Sheldon Slabbert: Tricky balancing act in oil markets

Price is lower now than at the start of Opec cuts. Photo / 123RF

Opinion

• Sheldon Slabbert is a sales trader at CMC Markets New Zealand.

Thursday marks the first meeting of the year for Opec in Vienna, Austria. It will also be the first meeting, following an agreement reached in December 2016 to collectively cut 1.8 million barrels of oil a day from the global supply over six months.

The intention is to rebalance the market, bring global supply into line with demand, and ultimately see a sustained recovery in the price of oil.

Since the agreement took effect in January the response has been largely positive, but the recovery in prices has since run out of steam. As a result, the price of a barrel of oil is actually lower now than at the start of the production cuts.

Opec members have said they will be satisfied with an oil price in the US$60 to US$70 per barrel range, and with prices languishing on average below the US$50 per barrel mark since the inception of the production cuts, it's widely expected that the agreement will be extended for another nine months, and that quotas could be further reduced.

Decisions made by the 12 Opec member countries undoubtedly have a big influence over the price of oil. Just look at what happened three years ago, when decisions to increase production led to the price of oil falling down an elevator shaft from a high of around US$115 per barrel of crude in June 2014, to about US$27 in January 2016.

The big reason behind the price collapse was a sharp increase in output by certain Opec members, predominantly Saudi Arabia. The strategy was aimed mostly at driving US shale oil producers out of the market.

US shale oil was seen as an easier target, as that industry had a higher break-even level and carried high levels of debt.

The Saudis thought that a drop in revenues would force bankruptcies among US players and that they could fill the gap left by their exit.

However, this strategy backfired badly as other non-Opec members, like Russia and Canada, also increased output in response. This resulted in a supply glut in the market that drove prices through the floor.

The decline went further than the Saudis had anticipated, and other Opec members seemed to be collateral damage as a consequence of their move, with devastating effects on countries like Venezuela.

The US producers have also proved to be more resilient than Opec had anticipated, and while they certainly felt the brunt of the aggressive pricing strategy by Opec with operational rigs falling from a high of 1591 to a low of only 316, they have since recovered to 742.

These rigs are also more productive than many of their predecessors, with US shale supply growing rapidly. Opec now fears that an extension will boost prices just enough to allow shale companies to hedge prices once again, enabling them to maintain and even increase supply further.

The recovery in US shale is also creating supply balance concerns for 2018, by when it is estimated that US daily production could increase by a further 64 per cent.

Opec has recently been able to gain co-operation from other non-Opec members, such as Russia, which has emerged as an important swing producer to manage output in support of prices going forward.

Opec has a difficult road ahead in rebalancing the supply side following its misadventures of oversupply, which has also placed a big strain on relationships within the cartel itself. Drastic action may be needed which could catch markets by surprise.