Oil’s Deceptive Balance: Have Prices Really Stabilized?

Since January 2017, when OPEC and Non-OPEC countries began implementing their oil production deal, the price of oil has been deceptively balanced. The spot price for Brent crude has fluctuated between $53.18 and $55.91, a %5 increase, but only mildly so. (For comparison’s sake, the price fluctuated between $35.56 and $27.36, a 23% drop, during the same period in 2016).

However, this does not mean that oil prices have stabilized. In fact, the oil market seems especially in danger of unbalancing right now. Every piece of information indicating that the supply glut is abating is counteracted by data indicating otherwise. Imagine a scale on which data about OPEC production pushes the scale down on one side. This is counteracted by reports of higher rig counts and growing crude oil stores in the U.S., which pushes the scale down on the other side.

At some point, one side will tip farther than the other can compensate for. The questions are: which side will be heavier? And when?

OPEC released its official report on production cuts on Monday and declared it a resounding success – 93% compliance. (The compliance rate differs based on the reporting source. The OPEC report is supposed to use a combination of self-reported production data and data from several independent sources). In the same report, OPEC also revised its demand forecasts upward slightly. Compliance rate is a key figure, but perhaps not as important as the fact that Saudi Arabia cut even more than expected – nearly 500,000 bpd – which offset production increases from Nigeria, Libya and Iran.

On the other side of the scale, last week’s EIA report showed that U.S. crude oil stockpiles grew by 13.8 million barrels. The active rig count also rose by eight to 591. (Rig count is not necessarily a direct indication of oil production growth because shale oil production often relies on DUCs, drilled but uncompleted wells, which can be accessed to increase oil production without increased rig count). The OPEC report offset losses from the EIA report, but it is likely that the next EIA report will show additional builds because U.S. refineries (working at full capacity now that it is also time for seasonal maintenance) cannot draw and process enough crude to keep up with the amount produced and imported. As a result, there is a backup of crude in the U.S. giving the image of excess supply.

It is clear that OPEC is already concerned about its ability to keep oil in the mid-$50 per barrel range under the current situation. Members and non-members are already discussing plans to extend the production cut deal. However, there are some indications that, come June, this may not be necessary.

Under the conditions of the current deal, Iran was allowed to continue to increase its production. Data from TankerTrackers.com indicates that much of the reported increase in Iranian production is likely a massive sell-off of oil that Iran had been storing in tankers in the Persian Gulf. According to its data, Iranian floating oil storage is now at a post-sanctions low of 15.3 million barrels.

Second, oil demand in India is currently depressed as the Indian government tries to remove all high-value currency notes from circulation. Most customers in India pay for gasoline and diesel fuel in cash. This led to a 7.8% drop in diesel fuel use in January and is now impacting India’s crude oil demand (India imports almost 80% of its fuel). Analysts, however, expect that India’s demand will recover in March when the demonetization process is complete.

If Saudi Arabia keeps production low, Iraq follows through with its promised cuts, Iran runs through its floating storage and Indian demand recovers, then OPEC may not need to rely on speculative talk to keep the price of oil from dipping too far before June.

U.S. refineries will also likely draw more crude oil as they start to produce summer blend gasoline in preparation for the summer driving season, creating the appearance there is less supply in storage. All of these factors could tip the scale in favor of higher prices, despite increased shale production.

On the other hand, Saudi Arabia is likely to increase its own production as summer approaches, Iraq may not follow through with its production cuts, Nigeria and Libya may continue to increase production, Russian production may return as the Siberian winter ends and U.S. refineries may not draw nearly as much crude oil as hoped for. If these factors come true, oversupply could win out and OPEC would need a serious commitment (a heavy weight on the scale) to prevent a price drop.