Oil & Gas June 2017
OPEC Extend Cuts, Markets Cut Prices

OPEC members and allies met again on May 24th and decided to extend the production cut agreement until March 2018, this was followed by an unexpected 6% drop in crude prices. The original agreement to cut production has achieved a record 90% compliance. However, bullish market sentiment has eroded rapidly as US shale production continues to surprise and inventories remain high. Futures markets reflect the expectations that long-term oil prices have stabilized at around US$50, probably driven by the costs of US shale producers.

OPEC members and allies met again on May 24th to discuss an extension to the production cut agreement that has been in place since January 2017. When the cartel first agreed to constrain production last November, Brent crude prices surged 18% within a trading week, notching its biggest gain in 6 years. This time, OPEC's decision to extend the cuts was followed by an unexpected 6% drop in crude prices. What does that mean for oil markets?

The original production cut has been a success in terms of compliance. Member states and non-OPEC members such as Russia, Mexico and Oman have complied and cooperated at an unprecedented level as they aim to cut 1.8Mbpd. Actual compliance has been around 90%, or 1.56Mbpd, a historical record for OPEC. The Brent price averaged almost US$55/bbl during the March Quarter of 2017, nearly US$15 more per barrel than in the same period last year. Nevertheless, plenty has changed –or remained unchanged– in the last six months which has eroded bullish market sentiment.

Despite OPEC’s efforts to curb production, shipping and inventory data reveals global oil markets remain well supplied. OPEC exports to its biggest customers, the US and China are over 10% higher than a year ago. Thus far, production cuts have not been evident in export market volumes. We expect OPEC members have increased exports by drawing from their bloated oil inventories. The amount of oil in visible floating storage on the Persian Gulf has decreased from around 40Mbbl to 15Mbbls during the March Quarter of 2017. This draw-down from inventories has added approximately 280kbpd to the market. This additional oil is more than the 210kbpd that Iraq, the second largest OPEC producer, had to cut. Restricting exports would have had a far greater effect on global prices.

Spreads like the Brent-Dubai and WTI-Dubai exchange of futures for swaps have remained narrow and global freight rates remained cheap. This means there are very few constraints in place preventing crude from the US, North Sea, Latin America, and West Africa from providing Asia the barrels OPEC and its allies are cutting.

Hedge fund positions also demonstrate that a rather bearish picture has been developing since February against oil in both futures and options markets. Furthermore, consecutive cuts in net-long positions in WTI and Brent holdings, further indicate that hedge funds are no longer over invested in the oil market. This is illustrated by the Commodity Futures Trading Commission (CFTC) data on non-commercial oil positions.