OPEC's Compliance Woes

The recent revival of $50 per barrel crude for WTI futures has inspired oil bulls, although the false break certainly puts the direction in which prices are heading into question once again.

Oil Barrels

In the demand-supply equation, there are little doubts that global oil demand is set to rise in the longer-term, the uncertainty in production however remains a constant debate.

OPEC’s role

Oil markets have been swayed recently by news from OPEC and co., charging higher as the coalition avowed lower production from the month of August before plunging on news of higher-than-expected production levels. Notably, members including Libya and Nigeria, unbound by production caps, have been cited like problem children of the lot while OPEC’s overall compliance had been seen at only 86% in July. The latest OPEC compliance meeting certainly went about trying to improve this issue with conclusions of the meeting suggesting that laggards are expected to better adhere to agreements and seek full conformity, though details on how this would be achieved were absent.

Zooming into the root of the issue, we find a group of major oil producers trying to rein in prices via output in order to fend off a key competitor, the US. Simply put, this is an evolving problem of game theory. Comparatively, decentralised producers in the US respond primarily to price signals. While pinpointing the constantly fluctuating breakeven price for US producers may be a herculean task, we have seen softer crude prices, particularly the recent sub-$46/bbl range, exerting pressure on US crude producers of late.

Rig counts have visibly witnessed a cap, plateauing just above 760, as reported by Baker Hughes, while crude inventories clocked consecutive weeks of drawdowns into the end of July. On the other hand, one would also recall that recovering crude prices since 2016 have brought many oil rigs back online, capping prices on the top end and producing this wedge for prices against OPEC’s output levels. The behemoth task of curbing supply to push up prices certainly appears to have fallen upon OPEC’s shoulders.

Outlook positive?

For the nearer term, we may however expect some upsides with crude. The latest renewed commitment to improve production compliance by OPEC may be the panacea for near term gains, if effected, riding against the backdrop of slowing US output. Seasonally lower Saudi Arabian production from the month of August coupled with higher global oil demand also places the bias on the upside for prices. Prices may find their way towards the higher end of the consolidation rage, looking towards $52/bbl with a break above the $50/bbl psychological resistance for WTI futures.

Long term price trend on the other hand may not be as clear cut. While the International Energy Agency in their latest July update has reinforced their view that world demand remain on the rise, upgrading their global demand forecast for 2017, the uncertainly remains with output. Moving ahead, the next inflection point may be the next OPEC meeting in November where the coalition would have to debate further the current output cuts. To achieve their goal of seeing prices take off from the current range, OPEC may have to do more than keeping to the current 1.8 million barrel per day reduction in output.

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