OPEC's Hope for Goldilocks Price Fade: Kemp

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Posted by Joseph Keefe

CERAWeek has exposed all the contradictions at the
heart of OPEC's attempt to rebalance the oil market without
rekindling the shale boom or conceding too much market share to
rivals.

The oil industry conference in Houston started with a celebration
of higher prices, progress towards drawing down global
stockpiles, and optimism about the outlook for shale producers.

But it ends with the biggest daily fall in prices for more than a
year, fears that stocks are not declining as planned, and
warnings that shale producers could cause a renewed slump if they
increase output too fast.

STAYING IN STEP

OPEC members led by Saudi Arabia have reported nearly full
compliance with output cuts announced last November, though
performance remains very uneven across the group.

Once again, Saudi Arabia has made the deepest cuts to offset
patchy compliance by other members, returning to its hated role
of swing producer.

But OPEC's rush to increase output before the accord took effect
in January has left the market bloated with crude that continues
to show up in the statistics as tankers arrive in North America
and unload.

The attempt to beat the deadline has made rebalancing harder and
effectively moved the market against the organisation's own
members.

OPEC enlisted support from 11 other countries to spread the
burden of rebalancing and protect its market share but compliance
from non-OPEC countries has been much lower.

The organisation's members have been forced to discount their
selling prices to protect their prized relationships with Asian
refiners.

And OPEC has encouraged hedge funds and other money managers to
believe prices will rise to $60 per barrel or more.

Hedge funds have accumulated a record bullish position in crude
futures and options amounting to more than 900 million barrels in
the expectation that prices will climb.

Hedge funds nearly all expect the organisation's output cuts to
be extended beyond their current expiry on June 30 to draw down
stockpiles.

But OPEC and Saudi Arabia have spent CERAWeek warning shale
producers against raising output too much and assuming the
production cuts will be extended automatically.

Saudi Arabia has pointedly warned shale producers that it will
not cut its own output simply so they can grow theirs ("Saudis
tell U.S. oil: OPEC won't extend cuts to offset shale", Reuters,
Mar. 9).

Without an extension, however, global oil production would rise
by more than 1 million barrels per day at the start of June, and
oil prices would likely swoon.

PRICES JUST RIGHT

OPEC wants to push prices higher while simultaneously protecting
its market share.

The organisation is trying to find the Goldilocks price -- high
enough to boost revenues and keep hedge funds bullish, but not so
high it sparks a renewed shale drilling boom.

The problem is that the Goldilocks range is fairly narrow, and
may not even exist at all in a form that can satisfy all the
interested groups OPEC has tried to assemble in its cooperative
framework.

Most estimates suggest the breakeven price for shale, at which
production can be sustained, is currently around $50 or $55 per
barrel. Prices of $60 or $65 are expected to result in a
substantial increase in production.

But hedge funds have already accumulated a record bullish
position with WTI and Brent prices around $50-55 per barrel and
need significant upside potential to keep them interested.

In the meantime, U.S. shale producers have already started to
increase output much faster than was expected six months ago.

And the market rebalancing process is taking more time than
anticipated, as Saudi officials admitted in Houston this week.
Reported stockpiles are not falling as fast as either OPEC or the
hedge funds expected.

OPEC's hope of shifting the futures market from contango into
backwardation has stalled, with calendar spreads for nearby
months weakening since the fourth week of February.

INVISIBLE HAND

OPEC, or in reality Saudi Arabia, faces the familiar dilemma: it
can focus on raising prices or protecting market share, but not
both.

This dilemma will be brought into sharp focus in the next couple
of months as OPEC decides whether to extend its production cuts
beyond June despite weak non-OPEC compliance and rising shale
output.

OPEC and Saudi Arabia control only a minority of global
production and cannot prevent development of extra oil resources
outside the OPEC area (other than by crashing prices).

In theory, it might be possible for OPEC to stabilise prices in a
narrow $50-60 per barrel range but it would require exceptional
deftness and a lot of luck.

Previously attempts to maintain prices within a narrow band in
the late 1990s and early 2000s, and again in 2009-2010 were
unsuccessful.

Efforts to stabilise oil prices have never succeeded for very
long for precisely this reason and it would be surprising if this
time was any different.

In practice, the market will be regulated by prices, which will
keep shale growth in line with demand from consumers.

Prices plunged this week because at least some traders revised
their view on the likelihood of an early reduction in stocks and
a quick rebalancing.

Concerns about the rapid resumption of shale drilling and the
possible re-emergence of surplus production also weighed.

Adding to those factors, the concentration of bullish hedge fund
positions raised worries the trade was becoming crowded.

For all the talk about production policies among the conference
attendees in Houston, prices rather than strategies still rule
the oil market.

By John Kemp

Mar 10, 2017

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