Oil Markets: How Long Will the OPEC Rally Last?

Oil prices have traded in a familiar range for most of 2017, as investors balance supply cuts from the Organization of the Petroleum Exporting Countries (OPEC) against signs of a booming U.S. shale industry. After hitting 18-month highs at the start of January, crude has failed to reach new heights, a sign the latest rally was losing momentum.

The West Texas Intermediate (WTI) benchmark for U.S. crude futures fell 98 cents, or 1.8%, to $53.07 a barrel on Monday, snapping a three-day winning streak. With the decline, U.S. crude is down roughly 1.2% since the start of the 2017. Brent crude, the international futures contract, declined $1.11, or 2%, to $55.59 a barrel on Friday. Brent is down more than 2% since the start of January.

Crude oil enjoyed a large rally at the end of 2016 after OPEC agreed to curb production by 1.2 million barrels per day, beginning in January. Less than two weeks later, 11 non-OPEC members, including Russia, agreed to reduce output by 558,000 barrels per day.

OPECIndustry analysts say both OPEC and non-OPEC members are complying with last year’s agreements. OPEC is achieving the best compliance in its history, and has so far implemented 90% of its proposed output cuts, the International Energy Agency (IEA) said in a report last week. Meanwhile, non-OPEC members have implemented about half of their promised cuts.[1]

The Paris-based organization also raised its outlook for global oil demand thanks to upbeat industrial activity and colder than normal early winter weather across much of the northern hemisphere.[2] However, despite lower OPEC production and stronger global demand, it is not highly expected for crude prices to skyrocket anytime soon. That’s because the latest price recovery has fueled the U.S. shale industry after nearly two years of downtime.

Energy services provider Baker Hughes reported last Friday that the number of active rigs operating on U.S. soil rose for the 14th time in 15 weeks to the most since October 2015. Drillers added a total of eight rigs in the week ended February 10, bringing the total to 591. During the same week, a year earlier, drillers had operated just 439 active rigs.[3]

Rising rig counts are a sign that energy companies are ramping up capacity. U.S. drillers have become much more proficient in recent years, allowing companies to turn a profit at more competitive price points.

OPECThe U.S. shale boom, which began in Texas more than a decade ago, went on to make the world’s largest economy also the biggest energy producer. Some investors fear that oil in the $50-$60 range will only encourage more U.S. companies to resume drilling, thereby negating OPEC’s production cuts.

U.S. crude inventories have also risen sharply in recent weeks. Data from the Energy Information Administration (EIA) recently showed that crude inventories rose by the third largest amount in history at 13.8 million barrels in the week ending February 3.[4] The silver lining was that gasoline stockpiles declined unexpectedly, a sign of robust demand.

Data on U.S. crude inventories are released every Wednesday by the EIA, and provide investors with short-term clues about the direction of the market.

OPEC’s latest efforts prove that the 13-member cartel can still influence the global energy market. However, it’s grip isn’t as tight as it was before. OPEC’s desperation was on display last November when the Saudis essentially capitulated to their Iranian counterparts by allowing them to maintain crude output while Gulf Arab producers cut theirs. This clearly suggests that the extent of the oil-price collapse has weighed disproportionately on the Gulf states, which rely heavily on crude exports for revenue.

The global energy market is notoriously difficult to predict. The combination of geopolitics, technological innovation and underlying supply/demand forces means that most forecasts become obsolete almost immediately after they are made. However, the latest rebound in prices suggests the worst of the oil crash is behind us, and that prices still have room for growth before U.S. shale floods the market once again.

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[1] Grant Smith (February 10, 2017). “OPEC Keeps Its Promise About Crude Oil Cuts, IEA Says.” Bloomberg Markets.

[2] Myra P. Saefong, Sara Sjolin and Jenny W. Hsu (February 10, 2017). “Oil up for the session, but barely registers a gain for the week.” Market Watch.

[3] Reuters (February 10, 2017). “U.S. drillers add oil rigs for 15th week in 15 – Baker Hughes.”

[4] Orangutan Capital (February 9, 2017). “Weekly Crude Oil Inventory – Third Largest Build In 35 Years.

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