|Years ago, I was laughing at the idea that Russia and Saudi Arabia could work together on an oil production cut.
Now, not only has the cut happened, but recent news indicates it will be extended through March 2018.
Even though my prediction that these oil powerhouses wouldn’t be able to get their act together was wrong, I still stand by the main points behind the argument: neither nation can afford to let oil slip again, and there’s only so much each is willing — or able — to give up.
What Has OPEC Done?
Despite how hard I am on OPEC sometimes, the only question we need to ask is whether the group’s plan to bolster crude prices will work.
So, is it working? Well… sort of.
Lately, crude prices have been hovering around $50 a barrel — a point that is certainly profitable for drillers in areas like West Texas.
I’m pretty sure that’s not what OPEC wanted to hear.
Obviously, the group is happy that prices are no longer in the $20/bbl range… but aren’t we all?
Granted, there was never a concrete goal, except to say that every producer would prefer higher, stable prices (the Saudis are hoping crude will be trading around $70 within the next 12 months). But the last thing we want to see is a price surge — something that could jeopardize the entire recovery.
Of course, the Saudis NEED crude to trade over $60 per barrel just to balance their own budget. Personally, I think that is grossly lowballing what they truly need to break even, especially considering that the House of Saud can’t keep up its lavish social programs without much higher crude prices.
Russia’s in the same boat.
And don’t even get me started on Venezuela.
So far, the need for higher prices is certainly the reason OPEC and Russia are finally working together and extending production cuts for another nine months.
Will that get oil to $70?
Not by itself it won’t…
Drawing Down the Glut
There are a number of factors to take into account when considering oil’s current predicament.
The first of these may sound a little obvious, but bear with me: how much oil do we have?
More specifically, what’s being stored in tankers and containment facilities right now?
Fortunately, we’re updated on these levels every week by both the American Petroleum Institute and the Energy Information Administration.
Those weekly reports show major storage facilities across the country.
But here’s the thing: much like watching a pot boil or a stock move, gauging the oil industry by weekly stockpile reports will drive some individual investors crazy and could very well cause knee-jerk reactions in the market.
For one, we’re still working our way through the huge amount of excess oil that built up before the production cut went into effect. Saudi Arabia was pumping at record levels at the end of 2016, and we’ve still not used all of that supply up.
It’s barely been five months — not nearly long enough to get rid of millions of barrels of excess oil!
We’ll get there, don’t worry.
And just because U.S. production is increasing — as is production in a select few OPEC countries — that doesn’t mean we’re in trouble. Remember, we’re right at the start of the summer driving season, and the U.S. hasn’t lost its thirst for gasoline.
In a recent interview with Platts, the International Energy Agency’s Head of Oil Industry and Markets Division Neil Atkinson noted that the world could in fact be facing a tightening of supply as soon as 2020 if oil demand continues rising as the Agency expects it to.
This estimate does assume that OPEC and Co. continue the cut, and that no other major events shift the weight of the oil industry one way or the other.
But that’s not as unlikely a scenario as it once seemed.
We can’t predict every change in the markets, but I can say with some certainty that Saudi Arabia and Russia do not want to see oil in the $20s again… or $50 per barrel, for that matter!
A Whole New Game
Keep in mind that the oil industry balance has already shifted, and I don’t just mean in price.
Even if Saudi Arabia and the rest of OPEC get back into the green, the oil cartel has undoubtedly lost some of the power and influence it once wielded in global oil markets.
U.S. tight oil production has taken its piece of that cake, and you can bet those drillers will keep pushing their product onto the global stage.
But it goes even deeper than that.
Another fun fact Mr. Atkinson pointed out in his interview is that few OPEC members have the same spare production capacity that they did in the ’80s when another glut put global markets in a similar situation.
Saudi Arabia may claim to have plenty of spare capacity, but it’s still not enough to keep the country’s hold over the oil market intact. Of course, that’s not to mention the fact that Saudi spare capacity is of a much poorer quality — we learned that much after the Saudis tried to make up for the shortfall of Libyan supply.
Ever wonder why the Saudis were suddenly interested in buying oil refineries in the Gulf of Mexico?
It’s not a coincidence.
Welcome to the new oil game.