Crude Economics
Can OPEC Erase the Oil Glut?

The collapse of the price of oil can be boiled down to very simple economics: supply outweighed demand. That truth helped drag crude prices down from a June 2014 high of more than $110 per barrel to a January 2016 nadir of less than $28, and it motivated the world’s petrostates to band together and cut their collective production to help erase that glut and send prices back up.

That agreement, hammered out in November and enacted this month, will run through June, and it has already brought oil prices back above $56 per barrel. OPEC’s members (and oil producers around the world) would like to see prices rise significantly more than they already have, but that won’t happen if the market isn’t balanced, which asks the question: will this cut of 1.8 million barrels per day be enough to erase the global glut? According to one hydrocarbon executive, there’s still a lot more work to be done. Bloomberg reports:

“We still have a significant global storage of oil, close to a billion barrels,” [Dana Gas CEO Patrick Allman-Ward] said Tuesday in a Bloomberg TV interview with Francine Lacqua at the World Economic Forum in Davos, Switzerland. Dana Gas, based in the United Arab Emirates, explores for and produces natural gas in the Middle East. Gas is often sold at prices linked to crude oil. […]

The potential for increased production from Libya and Nigeria will mean price volatility in crude for the rest of the year, he said. “There’s a lot of latent capacity in the system that is still not produced from Libya and Nigeria, and of course the oil shale is coming back in a big way,” the CEO said.

Bringing production levels down to be more in line with global demand will help stop the slide for producers, but it won’t be enough to eat away at the hundreds of millions of barrels still sloshing around in storage facilities all around the world. Reducing those stockpiles is going to take time, and those barrels will necessarily blunt the impact of these recent petrostate production cuts.

Of course, stored oil isn’t the only thing working against OPEC and Russia. As the Dana Gas CEO noted, Libya and Nigeria are chomping at the bit to restore lost production, a fact that will make those output cuts more difficult. But the real bogeyman for producers desperate for some price relief in the oil market are the American frackers, whose relatively high-cost production weathered the bearish market far better than anyone anticipated they would, and whose output has already started to climb. The U.S. is producing nearly 500,000 barrels more per day now than we were back in mid-October, and we’re once again knocking on the door of 9 million bpd. As prices climb, so too will shale output as producers are able to bring back online projects they shuttered over the past two and a half years.

This isn’t to say that achieving a market balance is impossible, however. The UAE oil minister, Suhail Al Mazrouei, told Bloomberg that he expects production cuts will reduce global oil stockpiles by the time they expire in June, and that effort will be greatly helped by China’s sputtering production, which is predicted to decline by up to 7 percent this year. But the glut OPEC and friends are targeting is huge, and their tools to take it on aren’t as strong as they used to be. And if you’re a petrostate oil minister, the one fact that will really keep you up at night is this: small, nimble U.S. shale producers are ready to snatch up whatever market share the Russians and OPEC are willing to cede for the sake of higher prices.

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