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The steep drop in the oil price over 2014 and 2015 is often blamed on slowing demand, particularly from China, but the depth of the fall was mainly a supply-side issue. Oil prices at $100 a barrel or more fuelled the boom in US shale production. That triggered OPEC concerns about market share and waning influence, which kept the group increasing production even as demand dropped and prices started to fall. The policy worked as US shale production stalled as oil prices dropped below cost for the producers. OPEC market share increased.
However, it has also caused massive fiscal pain for the OPEC producers, and that’s why the group appears finally to be edging closer to a supply cut deal after failing to agree several times in the past year. Such has been in the increase in oil production over the past few years, with OPEC production increases driven by Iran and Iraq’s return to the market as well as record production from Saudi Arabia, that even a deal to cut supply may not be enough to rebalance the global oil market in 2017.
Does Trump herald second leg of US shale oil boom?
There’s now a new consideration for the OPEC producers: Trump’s victory in the US presidential election. The incoming president targeted OPEC frequently during his campaign, accusing it of holding the US hostage and threatening to block all imports from OPEC members like Saudi Arabia.
It’s likely a lot of this rhetoric was campaign bluster, and we have no idea what Trump’s policy towards the Middle East will actually be. However, Trump also claimed he’d make the US energy self-sufficient by backing fossil fuel production, opening up more federal land for oil and gas exploration and cutting regulation and red tape. The US is currently a long way from self-sufficiency, importing over seven million barrels a day of oil, but this scenario isn’t as fanciful as it once was thanks to the boom in shale oil and gas which has doubled oil output. Any push to boost US shale production further will again pitch the US against OPEC. And any battle on the supply side is going to weigh on oil prices.
OPEC has the advantage short-term
In the short-term, OPEC still has the price on its side in terms of this battle. US shale oil production is more costly than conventional oil production, even though the costs are falling. However, if OPEC does manage to agree a supply cut and prices start to rise again, it’s likely US shale production will ramp up quickly once more. And if Trump does put his policy weight behind a further ramp up in US production over the longer-term, then it’s going to be an increasingly important market factor for years to come.
The question for the very short-term is whether OPEC will actually agree a supply cut. The rhetoric from OPEC members has been swinging for weeks and that’s kept the oil price moving in a range between about $42 and $52 a barrel. Saudi Arabia is once again confident a deal can be reached and non-OPEC producer Russia is supporting it. But Iran is still lukewarm, and Iraq thinks it should be exempt from a deal because of its fight with Islamic State militants. There are more twists and turns ahead of OPEC’s formal meeting on November 30.
The question then is whether OPEC members stick with it?
It is quite possible to argue the market is firmly underestimating the chances of an OPEC deal. Even if, in the long run, a Trump win boosts oil production, in the short-term we may see an oil bounce. Over the longer-term, the price needs to break above $52, which was key resistance in June and October. From a purely technical perspective, a daily close above here could open the way to the June 2015 highs at $62.56. A failure to maintain a rally above $50 could see a return to $42 and then down to the August low at $40.