OPEC Fails Again

Jim Brown
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The combination of the OPEC production cut extension and eight weeks of inventory declines in the U.S. were not enough to lift prices.

Last week OPEC announced an agreement to extend the 1.8 million barrel per day production cut that took effect on January 1st, for another nine months until the end of March 2018. In theory, this is exactly what the market wanted but OPEC had already spoiled the party by teasing the potential for deeper cuts, more participants, a longer timeframe or a combination of them all. Traders were expecting great news and all they got was old news. Russia and Saudi Arabia had announced a week earlier they were going to extend the cuts through March.

Goldman Sachs said today that OPEC should be more like the Federal Reserve. They should keep their mouth shut ahead of big events and then provide some forward guidance with the announcements that gives traders some expectations for what happens when March arrives. The Fed has a mandated quiet period for the week before a meeting. That builds the suspense for the eventual announcement and keeps Fed heads from deviating from the official statement.

Traders are worried about what will happen in March. The production in the U.S. has already risen 576,000 bpd since the OPEC cut went into effect on January 1st. Analysts expect another 500,000 bpd by the end of 2017 and another one million bpd in 2018. That puts OPEC in a tight spot.

Libya is not bound by the production cuts and their production has risen from 330,000 bpd to nearly 827,000 bpd over the last nine months. This is the highest production since October 2014. They expect that to rise to 900,000 bpd over the next several months. Before the civil war Libya was producing 1.6 million bpd so they have plenty of capacity as they work to repair their fields and infrastructure. Nigeria is also not bound by the agreement and Iran and Iraq are known cheaters as is Russia.

Russia claimed they have reduced output by 300,000 bpd but they are shipping more oil now than they were before the production cut. Multiple countries have figured out they can produce for "inventory" and not have it count towards their quotas. The key point is the inventory. As long as inventories are rising the problem is still growing.

U.S. imports from OPEC countries rose 180,000 bpd to 3.36 mmbpd in March despite the production declines. Do you see what is wrong with this picture? The actual oil on the market is rising rather than falling.

Multiple alphabet agencies including the IEA, EIA, OPEC and others claim global inventories are declining 700,000 bpd and global demand for 2017 is expected to rise between 1.2 and 1.4 million bpd. If that sentence was true we would be in good shape. Inventories would decline and prices would rise. However, with production rising from Mexico, USA, Libya, Nigeria, Iraq and Iran, to name a few, plus the cheaters, the rate of growth is roughly equal to the expected rise in demand. In May, OPEC produced 470,000 bpd above its targets despite 95% compliance to the January cuts.

As long as OPEC leads traders to believe that production will resume at the end of March, the price of oil is not going to rise materially. Everyone will expect that 1.8 mmbpd to instantly hit the market and prices are going to tank months in advance. OPEC needs to bite the bullet and say they are going to limit production until prices reach a certain dollar per barrel and then adjust production to keep the price level. Analysts believe that magic number is $65. That is not high enough to justify deepwater drilling but it is high enough for OPEC countries to keep their bills paid.

Another factor roiling the investment market is Peak Oil but not the peak you are thinking about. Several years ago the worry was Peak Oil production but the technology in the shale fields has delayed those worries for about another decade. However, now there is fear of Peak Oil Demand. With mile per gallon standards for new cars so ridiculously high today and headed a lot higher at least in the USA, the demand for gasoline is going to slow. Add in the price of a new car at $60K to $80K for the big gas guzzlers and that is another reason demand will slow. Factor in the anticipated one million electric cars per year by 2020 and yet another reason demand is expected to slow.

We are not at Peak Demand yet but we could be around 2020. Another factor that will push that date farther into the future is the expectations for oil prices to remain low. As oil production increases, gasoline prices will decline and that stimulates demand. People decide they can afford a car or a bigger car with gasoline at $2.40 a gallon.

There is no easy answer to where oil prices are going except that they are not going significantly higher without a war in the Middle East. Prices are likely trapped in a $45-$55 range although some analysts believe we could see $60 for a brief period later this year.

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  Active Rigs

Active drilling rigs rose +7 to 908 for the week ended on Friday 5/26. Oil rigs rose +2 for the week to 722. Active gas rigs rose +5 to 185. Active rigs peaked at a high of 1,931 in September 2014. Active offshore rigs were flat at 23 after peaking at 61 in 2014.

Oil Inventories Week Ended 5/26/17

Crude inventories fell -6.4 million barrels to 506.9 million. This was the 8th consecutive week of declines totaling 25.4 million barrels. The historic high at 543.4 million was on April 29th, 2016.

Refinery utilization rose from 93.5% to 95.0% as refiners begin flood the distribution system with summer blend fuels.

U.S. production rose +22,000 bpd to 9.342 mbpd. That is a decline of 268,000 bpd from the peak in 2015 of 9.61 mbpd.

Cushing inventories fell 800,000 barrels to 64.8 million.

Gasoline inventories declined -2.9 million barrels to 237.0 million and should continue to decline over the coming weeks as summer driving increases.

Distillate inventories were flat at 146.7 million barrels.

Details in the graphic are for the week ended May 26th. All numbers are not available until the Friday of the following week. In the graphic below, green represents a recent high and yellow a recent low.

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