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Shai Heffetz

What do commodity traders need to know about OPEC's oil production dispute?


OPEC member countries recently met in Vienna to discuss the issues of production, market share, pricing and strategic policy. Saudi Arabia spearheaded the discussions which failed to reduce supply in favour of market price considerations. Rivalry between the Saudis and the Iranians continues, especially now that Iran will be re-entering the international oil trading arena.
The issue is clear: oil supply remains substantially higher than oil demand. The differential has resulted in massive stockpiles of oil inventories off the coasts of oil-producing countries. Oil tankers are loaded to capacity, and this is driving down the price of crude oil amid global economic weakness.
The 13-member OPEC cartel is responsible for approximately 40% of global production. The balance is dominated by non-OPEC countries and Russia, with the US leading the way as the new swing producer in global oil production.

The dispute within OPEC

The consensus reached at the fiery meeting was as follows: OPEC will not cut production unless non-OPEC countries move in a similar fashion. The argument was that, even if OPEC reduced its output by 5%, this would have a negligible effect on the price of crude oil and would only serve to undermine the market share of OPEC countries.
As it stands, OPEC is engaged in a power struggle – a war of attrition with WTI crude oil producers (shale oil producers in the US). This ongoing tug-of-war has resulted in a dramatic reduction in the number of oil rigs operating in the US, according to recent Baker Hughes data. OPEC has established a quota of 30 million barrels per day, but it regularly flouts this level and is actually producing 31.5 million barrels per day at present.
Increased production with depressed demand leads to a supply glut and persistent weakness in the price of WTI and Brent crude oil. OPEC’s decision – or the lack of consensus – resulted in the price of crude oil slipping beneath the critical $40 support level. WTI crude oil is trading around $38 per barrel and Brent crude oil around $41 (Monday afternoon). The 1-year forecast for WTI crude oil is $45 per barrel.
There are effectively two groups within OPEC competing against one another: Saudi Arabia, Qatar and Kuwait on the one hand, who believe that low oil prices will remove high-cost producers from the market and ultimately lead to a re-balancing of the oil price, and countries like Iran and Venezuela who believe that OPEC members should stick to the production quotas so that prices can rise.
The meeting on Thursday 3 December proved to be a highly charged affair, with member nations jockeying for position from opposing ends of the spectrum. There is presently no consensus among the 13-member group, and Iran’s proposals fell on deaf ears.
In 2016, Iran will be able to pump massive quantities of crude oil into the global markets after sanctions relief is enacted. However, this will do precious little to assist Iran if the price of crude oil is at historic lows. The tension within OPEC is palpable, and Saudi Arabia and its Gulf allies refuse to cede power to the emergent power bloc spearheaded by Iran.

Consequences of the OPEC dispute

As expected, disagreements within OPEC resulted in the price of oil slipping further. However, crude oil inventories are decreasing at a rate of knots. Throughout 2015, the EIA posited that upwards of 1.8 million barrels of crude oil inventories were being produced, and that figure is expected to be sliced in half moving into 2016.
This will mean that, as the number of producers diminishes, output capacity will decrease and inventories will be used up. This will lead to a gradual normalisation in the demand and supply of crude oil. Prices will invariably rise as inventories shrink, and futures markets will start to factor this into the pricing as we move forward.
Already the US shale industry is taking heat with the rig count declining by 10 according to the latest Baker Hughes report. Prices will continue to move lower as the glut floods markets with black gold.
Key points:

  • Oil has declined by more than 4% since the OPEC decision on Friday
  • Oil prices have declined more than 50% over the past 1.5 years
  • Support levels in oil production do not exist at this stage – the price can move into the $30 range or perhaps even into the $20 range
  • Saudi Arabia can sustain a war of attrition against WTI crude oil producers for an interminable period of time
  • The EIA anticipates a production cut of 400,000 barrels per day in 2016 for US producers

Brett Chatz
Intertrader.com
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The content of this article is the personal opinion of the author and not Intertrader.com. The information and comments provided herein under no circumstances are to be considered an offer or solicitation to invest. Nothing herein should be construed as investment advice. The information provided is believed to be accurate at the date the information is produced.

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