Comment: OPEC is toast, oil can drop further

- By Jasper Lawler, Senior Market Analyst at LCG-

The OPEC cuts aren’t enough

Oil prices slumped to a three month low on Wednesday having just suffered the biggest weekly decline since October. More losses could be on the way.

The resurgence of US oil production in conjunction with a steady expansion in oil rigs is undermining confidence that OPEC output cuts will end the supply glut. Even if the OPEC and non-OPEC output cuts were enough to offset US production, evidence from OPEC’s own monthly report in March suggests member nations are not complying with the agreed quotas.

OPEC vs non-OPEC

The battle lines are being drawn by non-OPEC. US shale as well as other beaten-down parts of the oil industry including in the North Sea are coming back to life. New efficiencies, including a lot of job cuts mean an oil price above $50 per barrel is profitable for many producers.

It’s not just US shale but Big Oil that deserves consideration. Oil majors are finally reversing the pause in production growth with a combined 15% increase in total crude output planned by 2021 according to Reuters.

Donald Trump’s executive orders to build the Keystone and Dakota pipelines suggest US energy policy is shifting. All signs are that Trump’s America will rely more on carbon energy and produce more oil.

A chance the Saudis backtrack

Saudi Arabia’s oil minister Khalid al-Falih told a conference of oil magnates in Texas that the OPEC deal was sowing "green shoots" for the US shale industry. Mr Falih is voicing what many oil traders have been thinking.

It was the concern that cutting OPEC output would play into the hands of producers who were not part of the agreement that led to Saudi Arabia’s recently abandoned policy of non-intervention in the first place. We were surprised by the OPEC decision to cut output in November because we thought Saudi Arabia understood it would be ineffective.

It beggars the question: Why did the Saudis reverse their opinion on an OPEC price cut? It is our opinion that the OPEC production cut is a face-saving campaign for a redundant cartel. The Saudis seem to have decided that supporting higher-cost producers within OPEC was for the greater good of the cartel, even if it meant losing market share.

Record bullish oil bets call a top

The OPEC & non-OPEC supply deal generated record bets on a rise in the price of oil, but so far they haven’t paid off. CFTC data from Friday March 10 showing a record net long position of nearly one billion barrels of oil was a sentiment extreme. The result is the market has rolled over. Quite simply, almost everyone in the market was long already and it wasn’t sustainable.

The bullish bets at the top of the 9-month old $45 - $50 per barrel price range clearly reflected the belief in a breakout into a new bullish trend. Now that the breakout has not materialised, we suspect a bigger unwind of the bullish positions will carry the price lower still.

Oil will stay in a price range

The oil market is in a new paradigm where prices are not controlled by OPEC supply, but rather by the profitability of private, competitive US producers.

Once Saudi Arabia starts to see the fallacy of the output cuts, we think there is a good chance the quotas are once again abandoned. This is not a base case scenario but the increased threat of it from falling oil prices puts additional downside pressure on oil. Even if OPEC complies with existing quotas, or makes additional cuts, the reaction to the resulting price rise will be higher US output which eventually drives the price lower. Hence we see oil in a $40 - $60 range into 2018.

The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest and nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced. Losses can exceed deposits.

- By Jasper Lawler, Senior Market Analyst at LCG -