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The Oil Glut is Gone, But Investors Still Agonize Over Production

Summary: Speculation of a production increase from OPEC is not as big of a deal as some market pundits are making it out to be, in MRP’s view. With global oil demand rising, there is relatively little spare capacity to make up for the continuing collapse of Venezuelan output, the upcoming drop in Iranian exports due to new US sanctions, and the possible shuttering of wells by US shale producers due to insufficient pipelines.

Oil markets have suffered from jitters lately as this week’s OPEC-hosted gathering of energy ministers from around the world looms large. The majority of speculation has pointed to an increase in production for OPEC, as well as Russia and a syndicate of 9 other nations that have been a part of the 18-month long cut of 1.8 million barrels of crude per day that balanced global oil stocks. Russia’s energy minister, Alexander Novak, has personally advocated for an end to cuts while Saudi Arabia already raised production in May by about 161,000 barrels per day (bdp). While Russia has additionally proposed a hike of 1.5 million bpd, effectively wiping out the cuts, such an extreme change of pace is unlikely.

Other countries involved in discussions have said that a more modest increase of around 500,000 – 600,000 bpd is being considered. Gulf producers usually aligned with Saudi Arabia – the UAE, Kuwait, Oman and Bahrain – have explicitly cautioned against a large output increase, but the largest obstacle standing in the way to a production boost is Iran. Iranian Oil Minister Bijan Zanganeh said on Tuesday that he disagrees with any increase in production, although other conflicting reports have signaled that Iran is already planning for a production boost of 400,000 bpd.

Iran does have the power to veto any production increase, but both Russia and Saudi Arabia maintain a “nuclear option” that would allow them to bypass a veto and form a communique agreement that excludes Iran and other nations opposed to a deal. Even a Saudi-led group’s effort isn’t likely to be extreme enough to drive down prices. As MRP previously noted, the IMF claims that Saudi Arabia needs prices around $88 per barrel to balance its budget, up sharply from $70 per barrel last year.

Deal or no deal, a production increase from OPEC in such a tight market is not as big of a deal as some commentators and analysts are making it out to be. Perhaps, when inventories were still flush with oil, an exit from supply cuts could have been catastrophic for crude prices. However, that is no longer the case.  The International Energy Agency (IEA) warned just last week that global oil demand continues to rise, while there is relatively little spare capacity to make up for the continuing collapse of Venezuelan output, as well as a coming drop in Iranian exports due to new US sanctions on the country. Further, supply disruptions in Libya remain a daunting threat as 240,000 bpd was forced offline due to clashes between the Libyan National Army and rival militant groups. The shutdown of Libya’s two biggest oil ports, Es Sider and Ras Lanuf has resulted in The National Oil Corporation evacuating its personnel from the ports. Production losses had increased to 400,000 bpd as of June 18th.

China may also be about to set off a demand shock in the face of rising OPEC production as the country prepares to make US oil less competitive by slapping a 25% import tariff on it. China has purchased an average of 330,000 bpd of US crude oil this year. This added volume, combined with Saudi Arabia considering a second consecutive hike in Asian oil prices, this time as high as 40 cents per barrel, could send the international benchmark, Brent crude, even higher.

While this would seem bad for the West Texas Intermediate (WTI) crude, the US benchmark, few of the latest signals appear bearish. This week’s Energy Information Administration (EIA) report saw US inventories decline by nearly 6 million barrels against an expectation of only 3.7 million barrels, the largest decline since April.  Perhaps more significantly though, U.S. crude production was flat at 10.9 million barrels per day. That’s the first time there was no weekly increase in four months, and could be symptomatic of a longer-term trend.

US shale executives are beginning to worry about sustaining production growth as they may have to begin shutting wells within four months because there aren’t enough pipelines to get the oil to customers. The Permian basin, the largest shale field in the US, is growing at 800,0000 barrels a day annually and production currently stands at 3.3 million barrels a day. But total pipeline capacity is 3.6 million barrels, so the region will reach capacity in the next three to four months and the bottleneck may not ease for at least a year. If cheap oil from the Permian cannot flow freely, shale giants like Pioneer Natural Resources may have to source from Cushing, Oklahoma instead. This could cause a significant price disruption considering oil from the Permian in Midland, Texas trades at a $25 per barrel discount to Cushing.

To top it all off, strong demand factors should continue to keep markets tight. Strong global GDP growth would bolster crude consumption by 1.4 million bpd through 2019. In the shorter term, Summer is just arriving for the United States and already the EIA has reported an all-time high for weekly gasoline demand as vacationers begin weekend getaways and road trips. Jet fuel should also strain supply as Airlines for America expects a record 236.1 million people to fly between June 1 and Aug. 31, an increase of 3.7% from last summer.

Speculators have remained equally as fearful of any change in production from OPEC as they were last year when supplies were still overflowing. The reality, however, is that the supply glut no longer exists and producers definitely have some leeway when it comes to production.

MRP added Long Oil and US Energy to its list of themes on April 8, 2016. The Oil ETN (OIIL) has lately begun to underperform the S&P since the theme launch, returning 33% against the S&P 500’s 35% over that period. The Energy Sector ETF (XLE) has posted less impressive returns, gaining only 20% in the same span. In December 2016, we included Energy Services & Equipment on our theme list on the basis that those companies would benefit from a pickup in exploration and drilling activities. That group, as represented by the Market Vectors Oil Services ETF (OIH) is down 23% since we added it on December 23, 2016. However, the shortage of pipelines will undoubtedly be addressed, as part of the larger CapEx Boom, and assist in the rebound of oil services.

Given the global geopolitical and technical factors outlined above, we remain bullish on oil and are reaffirming our $60-80 price target for crude. Since the launch of the theme, the price of WTI crude has increased 65% from $39.74 to $65.71.

We’ve also summarized the following articles related to this topic…


Oil: The Biggest U.S. Oil Patch Is Near Its Limit

The biggest U.S. shale region will have to shut wells within four months because there aren’t enough pipelines to get the oil to customers. The worsening bottleneck in the Permian region that straddles west Texas and New Mexico offers an unexpected fillip to OPEC and other oil producers outside the U.S., who’ve seen rampant production from America’s shale producers grab market share.

The growth in the red-hot shale region is about to slow down soon due to a lack of pipeline capacity. The problem has grown so bad that oil companies have been forced to load crude on to trucks and drive it hundreds of miles to pipelines in other parts of the state.

The lack of pipeline capacity will continue to cause severe dislocation in U.S. oil markets. Benchmark West Texas Intermediate crude at Midland in the Permian is likely to trade at a $25-a-barrel discount to price at the industry’s hub in Cushing, Oklahoma.

The warning about shut-ins comes as some small companies move oil rigs away from the Permian into other shale basins that still have pipeline capacity. Oil services companies have also started to reduce the number of fracking crews they offer to drillers. The Permian region is accounting for nearly half of the growth in U.S. oil production. America pumped almost 10.5 million barrels a day in March, up 1.4 million barrels a day from a year.  B


Oil: Saudi Arabia may raise Asia official oil prices in July for a second month

Top oil exporter Saudi Arabia may raise the official selling prices (OSP) for most of the crude grades it sells to Asia in July for a second month, possibly raising flagship Arab Light to its highest since February 2014. The OSP hike follows signs of increased demand for Middle East crude oil as refiners gear up for the peak summer oil consumption period and increased buying by Royal Dutch Shell during the price assessment window operated by S&P Global Platts last month.

Dubai’s strength may mean Arab Light’s OSP for July could rise by as much as 40 cents a barrel to as much as $2.30 a barrel above the average Oman and Dubai quotes published by Platts, from $1.90 in June. That would be the highest Arab Light OSP since February 2014 when it was set at $2.45 a barrel.

Asian refiners are also buying record volumes of U.S. crude for arrival in the third quarter to replace Middle East, Russian and African oil after U.S. benchmark grade West Texas Intermediate fell to the widest discount against Brent since early 2015. In contrast, higher fuel oil margins last month and falling Venezuelan production are supporting higher OSPs for heavier grades. R


Oil: Iran Can Block OPEC Agreement, Yet Saudi Arabia Can Bypass Veto

Even with Iran threatening to block an increase in OPEC’s oil production, Saudi Arabia still has options. Tehran says it has Iraqi and Venezuelan support to veto any proposal for more output, a position taken by both Saudi Arabia and Russia. “If the Kingdom of Saudi Arabia and Russia want to increase production, this requires unanimity,” Hossein Kazempour Ardebili, Iran’s OPEC representative, said on Sunday, before the group meets in Vienna on Friday.

Yet Saudi Arabia can still bypass a veto. First, it can block any formal OPEC-wide communique. Then, it can gather a coalition of supporters within the group and publish its own statement, which could outline a new production policy.

Another option for the Saudis is to accept defeat on a formal production increase, but start cheating on output quotas. While that would also be in line with OPEC tradition, it would be a first for Saudi Oil Minister Khalid Al-Falih, who has stuck scrupulously to the agreements.

Iran acknowledged that both Saudi Arabia and Russia, which is part of the wider OPEC+ agreement, can bypass a veto, but warned that any such move would lead to the disintegration of the 2016 deal that has helped oil prices to more than double. B


Oil: Goldman: Expect Another Bull Run In Oil

The expected increase in oil production will not leave the market in a situation of oversupply, and in fact, barring no further action, the world could still be short of oil over the next year. There is no shortage of pitfalls for the bull run, with Trump’s expanding trade war, weaker demand and a potential currency crisis in emerging markets, and the drilling frenzy so far proceeding at an unabated pace in West Texas. Even with those considerations, however, “the oil market remains in deficit with resilient demand growth and rising disruptions requiring higher core OPEC and Russia production to avoid a stock-out by year-end,” Goldman Sachs wrote in a note on Monday.

The conclusion is notable because the investment bank assumes a rather aggressive increase in supply from OPEC+, on the order of 1 million barrels per day (mb/d) in the second half of 2018. The expected increase in OPEC+ production is needed, and won’t spark a market meltdown. The bottom is falling out in Venezuela and a long list of companies are packing up and getting out of Iran. Ultimately, Iran might see a sizable chunk of its oil exports disrupted because of U.S. sanctions. Libya and Nigeria are also in the midst of another wave of supply disruptions. OP

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