Not the same cartel of just a few years ago

March 27, 2017 08:18 AM
Daily Energy Market Analysis

A new dawn is breaking in the old OPEC cartel and it is a reminder that this is not the same cartel of just a few years ago. Instead of infighting and name calling, there is cooperation and order and that is why OPEC and non-OPEC will secure an extension of the OPEC production cuts. The so-called compliance committee met in Kuwait at a “technical” meeting to assess output cuts.

Instead of just counting barrels, they came out with a strong statement that most of OPEC and non-OPEC nations back a 6-month extension of their successful, from a compliance viewpoint, production cut. Russia's energy minister Alexander Novak said that there was a, "94%" compliance on the production cut among OPEC members and non-OPEC nations.

Five OPEC members and non-OPEC Oman, backed a six-month extension rollover of cuts with the Russian energy minister Alexander Novak saying it was too early to say whether there would be an extension, although the agreement was working well and all countries were committed to 100% compliance. Russia took its time to get in compliance but did so per the committee. Russia cut oil production by 161,000 barrels per day as of March 19, against October 2016. TASS reported that Russian average daily production in March was 1.51 million tons per day versus 1.532 million tons in October. That would be full compliance. 

The Russian oil minter will agree to an extension but he must make sure that Russian Vladimir Putin is on board. Vladimir had other things on his mind like rounding up political opposition on corruption charges. He is very busy trying to weed out corruption from anyone he views as a political threat. Iraq even agreed to extend cuts but only if they can get Russia to agree.

The odds are high that OPEC and non-OPEC will extend the deal. We predicted correctly that a deal would get done and compliance would be high and we also predicted -- and I am predicting again -- that OPEC and non-OPEC will roll over cuts for another six months. You see, as the Kuwaiti oil minister said, the cuts are already working. Even though if you focus on strictly on the U.S. market, you might not think so.

Record U.S. inventory creates an illusion of oversupply. If you look behind that mask you might see that we are on track for the biggest supply deficit in over a decade in just a few months. While big money interests flock to the shale path, we won’t be able to replace OPEC and non-OPEC production cuts and keep up with demand growth down the road. We saw the U.S. oil rig count jump by 21 to 652 this week, the highest level since September, 2015 per Baker Hughes. U.S. crude production, while on there rise, won’t offset OPEC and non-OPEC cuts. U.S. crude production is at 9.13 million barrels per day and while it is the most since February 2016, we are still below the 9.4 million barrels we were pumping a couple of years ago.

Not only that, shale won’t replace falling production elsewhere. Reuters warn that the structural decline in Asia’s crude oil production will remain over the next decade. Fitch research unit, BMI, said in a March 22 note that crude oil production in Asia is seen falling at an average annual rate of 1.1% over 2017-2026 as price volatility in the global oil market will keep driving upstream spending cuts. Crude output in China will continue to deteriorate alongside depleting conventional reserves, shifting government policy focus toward cleaner energy alternatives. Indonesia and Malaysia are also poised to see a long term decline in crude production due to a lack of new large scale projects post 2018, per the same report.

Reuters says that Chinese independent refineries, the so-called “teapot” refiners who are responsible for the surge in the country’s oil imports, are still consuming more oil this year. The operating rate at independent refineries in eastern Shandong province rose to record 60.39 percent of capacity in the week ending March 23, per industry website The rate is seen to be little changed this week, the website said.

Another headwind to higher prices has been producer hedging. Reuters reported that Barclays sees large capitalization U.S. exploration and production companies as having hedged around 28 percent of their oil production in 2017 and 3 percent of their oil output in 2018. Small, mid-capitalization companies hedged around 50% and 75% of this year’s output, while they hedged 20 percent of 2018 production. Hedging is a process to avoid risk by locking in a current price. So, the small to mid-cap firms are probably hedged up. That means less resistance next time we try to break out to higher levels. We know there is big money looking to invest which means they are confident that oil prices are near bottom.

The Trump Care defeat is weighing on stock markets and hurting oil prices a bit. Oil may follow stocks a bit but we should see a drawdown in crude stocks this week.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.