Opinion: Will oil prices rise or fall? Look toward Russia for the answer

Published: Apr 24, 2017 1:30 p.m. ET

There’s a global supply glut, but that could change in June

The only obstacle standing in the way of higher oil prices today is Russia.

There is only one thing standing in the way of higher oil prices, and it is not U.S. shale companies.

Anyone who follows oil CLM7, -0.79%  recognizes that U.S. production is increasing — rapidly — but those gains were expected by organizations monitoring oil, including OPEC and the EIA. Those monitoring organizations also recognize that the production growth of U.S. shale is significantly less than the production cuts that OPEC and non-OPEC members have agreed to already.

The only obstacle standing in the way of higher oil prices today is Russia. Where virtually all other participants in the production-cut agreement made between OPEC and non-OPEC members have confirmed support for an extension, Russia is yet to do that.

Importantly, Russia has not made any decision, to support or not to support, an extension of the existing deal. Instead it is evaluating the situation. Still, Russia has participated in group discussions that have concluded there’s a need for an extension.

According to our estimates of supply and demand offered by the monitoring organizations, if the OPEC agreement is extended through the end of the year, there will be a supply deficit of roughly 1 million barrels per day at times, and with that a significant reduction in global supplies.

Ultimately, reducing supplies is exactly what the OPEC agreement aimed to achieve, and statistics already show that it is working to reduce global supplies, even though it is not reducing oil supplies in the United States. But that can change, and it can change fast.

Using the same data from the monitoring organizations, there is still a global supply glut. But in June that is expected to change, given the current OPEC production-cut agreement. The market is expected to reach a balance where supply matches demand for the first time in years. The question is, will that persist beyond June?

With a focus on Russia, a realization must be observed, and with that the impact of oil-price fluctuations on Russian economic stability.

Although almost every other participating country has vocalized support for extending the agreement to cut production, many have also suggested that they could quickly ramp up production as well. Russia has said the same thing, so it is safe to assume that if production cuts are not extended, the balance between supply and demand will once again skew significantly, and supply will continue to outweigh demand and cause the glut to worsen.

This would be devastating to oil prices and to the Russian economy.

If Russia does not support the extension of the OPEC and non-OPEC agreement that currently exists, oil prices could plunge by 20% — in addition to the declines that came last week.

However, if the opposite is true, oil prices are likely to surge by more than 30%.

The differential between prices that would exist if OPEC and non-OPEC participants extend or do not extend the current agreement is significant, but particularly significant to Russia. Its economy has improved recently because oil prices have increased, but if oil prices fall, which they are likely to do if the agreement is not extended, revenues generated by state-run oil companies in Russia are likely to be 50% lower than they otherwise would be.

The hurdle standing in the way of higher oil prices is Russia, nothing more, but there are significant incentives beyond Russia to extend the deal. So far, though, Russia is the immediate focus, and the recent declines were absolutely because Russia has not come out in full support of an extension.

Because prices have been declining, however, and because that immediately hurts Russia’s economic stability, given the volatile nature of the recent decline, Russia has every incentive to vocalize support soon. And we expect the country to do that soon.

Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily. Kee managed the fourth-best-performing strategy in the world in 2016, according to HedgeCo.