OPEC Faces 'Lose-Lose' Decision on Extending Oil Production Curbs

By Myra P. Saefong, MarketWatch

Commentary by Curt Taylor, President of Ralph E. Davis Associates, an Opportune LLP company

EIA forecasts record U.S. crude production in 2018

Nobody said curing a global oil glut would be easy.

Next month, members of the Organization of the Petroleum Exporting Countries and their allies will have to decide whether to extend an agreement they made late last year to reduce their collective daily crude production by roughly 1.8 million barrels. The six-month pact kicked in at the start of this year.

But the oil producers, which include Saudi Arabia and Russia, face a lose-lose situation. If they don’t extend the deal, the oil market may continue to be oversupplied and prices will fall. If they do, prices will likely continue their climb—giving the U.S., which isn’t part of the pact, more incentive to boost its crude output, contributing to a global glut.

So far, OPEC members have stuck to the agreement at a high rate, with most estimates pegging compliance at close to 100%. A recent Reuters survey showed compliance at 95% in March.

“We are now half way into the six-month period of planned production cutbacks by OPEC and its allied partners,” said Mihir Kapadia, chief executive officer and founder of Sun Global Investments, in a note. “Over this period, we have witnessed relative stability in the oil market.”

Unplanned outages, such as the one at Libya’s Sharara oil field earlier this month, along with political tension in the Middle East, particularly following the U.S. airstrike on Syria, have contributed to some recent volatility.

But year to date, prices for West Texas Intermediate crude CLK7, -0.38%  have traded in a relatively tight range of $47 to $55 a barrel on the New York Mercantile Exchange, while Brent crude LCOM7, -0.39%  on the ICE Futures exchange in London, has traded between lows around $50 a barrel to highs just above $57.

“It is of course OPEC’s business to decide on its output levels, but a consequence of (hypothetically) extending their output cuts beyond the six-month mark would be bigger implied stock draws,” the International Energy Agency said in a report released Thursday.

But even though the oil market is likely to tighten throughout the year, “overall non-OPEC production, not just in the U.S., will soon be on the rise again,” the IEA warned.

“Even after taking into account production-cut pledges from the eleven non-OPEC countries, unplanned outages in Canada as well as in the North Sea, we expect production will grow again on a year-on-year basis by May,” it said.

The IEA sees global growth of 485,000 barrels a day in output this year, compared with a decline of 790,000 barrels a day in 2016.

“The main impetus comes from the U.S.,” it said.

So while an output-cut extension “would provide further support to prices,” the IEA said in its report. That, in turn, “would offer further encouragement to the U.S. shale oil sector and other producers.”

Record U.S. output on tap

The Energy Information Administration forecasts U.S. crude production next year of 9.9 million barrels a day. That would be the highest annual barrel-a-day figure on record, based on the agency’s data.

Charles Perry, chief executive officer of energy-consulting firm Perry Management, said the EIA is “on target” on its 2018 output forecast.

“I live in the Permian Basin, the most prolific of the new shale-producing areas,” he said. “I can gauge the level of drilling activities by the amount of traffic I see on the roads [and] by the number of new workers coming to town…these indicators indicate we are back at drilling new wells in quantities like we saw in 2015 and 2016.”

Recent data on the number of active U.S oil rigs revealed a 13th weekly climb in a row, implying future production growth.

“With eight additional rigs this week in the Permian…and three additional rigs in the Eagleford, U.S. producers continue to increase production back up to production levels reached before the [price] crash,” said Curt Taylor, president of Opportune LLP’s Ralph E. Davis Associates, referring to the Baker Hughes BHI, -1.46%  rig-count data for the week ended April 13.

“Increasing recoveries and decreasing costs, combined with available capital, will continue to propel these producers to drill, and so far, OPEC continues to cooperate,” he told MarketWatch on Thursday. “So, when does the rig count start to peak and when does OPEC exert some muscle? Maybe at the same time, but not today."

Extension odds

Saudi Arabia recently told OPEC officials that it wants to extend the output pact for another six months when the group meets on May 25 in Vienna, according to The Wall Street Journal.

“If this happens, it would help to support prices in the medium term,” said Sun Global Investments’ Kapadia.

But that’s far from a definite outcome.

In the absence of shale oil, Omar Al-Ubaydli, a program director at the Bahrain Center for Strategic, International and Energy Studies, said he believes oil producers would agree to extend the output cut deal.

But if the extension is secured, U.S. shale-oil will continue to expand, he said.

“I believe that [OPEC has] underestimated the positive reaction from shale oil, and that in light of this, I would say the likelihood of an extension is around 40%, heading downward,” said Al-Ubaydli

Still, “in an attempt to maintain market confidence, rather than doing ‘no deal’, they may do a reworked deal to project unity,” he said.

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