OPEC’s initial six-month deal to cut oil production failed to achieve its goal of shrinking huge global crude stockpiles.
OPEC will roll over production cuts on Thursday, an admission that an initial six months of output reductions were not enough to balance the market.
The policy has failed to shrink global crude oil stockpiles to OPEC’s target level, despite high compliance with a landmark deal with 11 non-OPEC members to remove about 1.8 million barrels a day from the market. The effort has been undermined by resurgent U. S. production, weak fuel demand and robust OPEC exports.
Now, oil market watchers are focused on the potential for the extension to finish the job — and what could go wrong.
OPEC has the wind at its back. Fuel demand is ramping up ahead of summer, when Americans take to the road for vacation and Saudi Arabia burns crude oil to meet electricity needs during the sweltering season.
“The important thing to consider here is that the world uses about 2 million barrels per day more oil in the second half of the year than the first half of the year, so if you’re ever going to impact supply-demand, the second half of the year is the time to do that, ” Jacques Rousseau, managing director at research firm Clearview Energy Partners, told CNBC’s ” Squawk Box ” earlier this week.
Provided overall compliance remains strong, the current level of cuts should be enough to shrink crude stockpiles in developed countries, said Tamar Essner, director of energy and utilities at Nasdaq Corporate Solutions. To get those inventories down to the five-year average, OPEC needs to force a drop of about 300 million barrels.
“In order for investors to buy in, they’re going to have to see that materialize, ” Essner said.
Achieving that goal requires OPEC not just to pump less, but curtail exports that are filling storage facilities around the world. So far, a drop in OPEC shipments has lagged the decline in production.
There is some progress on that front. Last month, loadings of crude oil onto tankers at Saudi ports fell by more than 670,000 barrels a day from October, the reference level for OPEC’s output deal, according to tanker tracking firm ClipperData. That means fewer Saudi barrels will hit the global market in the coming weeks.
But few other OPEC members are pulling back to the same degree, ClipperData’s Matt Smith told CNBC earlier this month.
Oil prices could struggle to break out of a range around $50 a barrel until the market is convinced exports are falling and stockpiles are drawing down. There was evidence of that on Thursday, as oil prices fell sharply on word that OPEC had agreed to the nine-month cut.
Having come to expect a nine-month extension, the market may now see that outcome as little more than “a good start, ” said Amrita Sen, chief oil analyst at Energy Aspects.
“I think the market now, given that they announced the nine months already a few weeks ago, is expecting something a little bit more, maybe deeper cuts, maybe at least keeping the door open possibly for more cuts if inventories don’t fall, ” she told CNBC on the sidelines of the OPEC meeting on Wednesday.
Saudi Oil Minister Khalid al-Falih said Thursday that continuing the cuts at the current level “is a very safe and almost certain option to do the trick.”
Michele Della Vigna, co-head of European equities at Goldman Sachs, said deeper cuts might actually be the best strategy. It would accelerate the market’s transition into “backwardation, ” when oil prices for immediate delivery are higher than prices for future crude shipments.
That would benefit OPEC. Instead, prices are higher for delivery 12 months from now, which works in the favor of U. S. drillers, who are funding production by locking in higher prices for future shipments and leaving crude in storage.
U. S. oil production has surged as prices stabilized around $50 a barrel throughout much of this year, offsetting the impact of OPEC’s production cuts.
This month, both OPEC and the International Energy Agency raised their forecasts for U. S. oil production growth in 2017. Goldman Sachs expects to see growth not only in Texas’ Permian basin — the epicenter of the U. S. shale oil rebound — but in other areas where drillers can produce oil at low costs.
“We think it’s a broad renaissance of shale led by incredibly cheap credit, ” Della Vigna told CNBC Europe on Wednesday.
There are also supply concerns emerging within OPEC. Nigeria and Libya were exempt from cutting production as they sought to restore exports that had been hampered by domestic conflicts, but their output has been bubbling up in recent months. However, analysts say continuing instability may limit gains.
It was not clear whether OPEC would impose any production limits on Libya and Nigeria.
