New Oil Price War Looms As The OPEC Deal Falls Short

By Nick Cunningham, a Vermont-based writer on energy and environmental issues. You can follow him on Twitter at @nickcunningham1. Originally published at OilPrice

Last November, OPEC orchestrated an impressive feat: corralling all (or nearly all) of its members to sign on to relatively aggressive production cut deal, and then actually convincing everyone to follow through on those reductions beginning in January. OPEC’s estimated 94 percent compliance rate defied the cartel’s own history of cheating and mistrust, and OPEC has taken around 1 million barrels of oil production per day off the market.

They were initially rewarded for this. Oil prices rallied more than 20 percent in the month after the deal was announced and investors and analysts have been mostly bullish on crude prices ever since. But the cuts were not all that they seemed to be for two reasons: OPEC cut from record highs and countries exempted from the deal ramped up oil production in the fourth quarter of 2016, offsetting much of the reductions.

Member countries (excluding Indonesia, which is no longer a member) producedabout 32.5 million barrels per day (mb/d) in August. That was the last month before the September Algiers accord, which was basically an agreement to agree to cuts at a later date.

By January, after nearly 90 percent of the 1.2 mb/d of cuts were implemented – or reductions of about 1.1 mb/d – the group still produced a relatively high 32.14 mb/d. Related: U.S. Shale Faces A Workforce Shortage

Why the disconnect? Pretty simple: OPEC used an October baseline, when production was more than 400,000 bpd higher than two months earlier. Cutting from a peak made the reductions seem much more dramatic.

Moreover, the countries exempted from the deal offset the steep cuts from countries like Saudi Arabia. Libya has added about 400,000 bpd in output since last summer, while Nigeria has added between 200,000 and 300,000 bpd.

So, we have OPEC talking up a major production cut deal, and also trumpeting its unprecedented rate of compliance. Oil investors listened, and became incredibly bullish on oil prices, expecting a sharp tightening in the market to be forthcoming. But while the participating countries have indeed taken about 1.1 mb/d off the market, they did so from their peak levels, and those cuts were offset by rising output from Libya and Nigeria.

To be sure, Libya’s output is once again under threat of violence near the country’s largest export terminals – Libya has already lost about 80,000 bpd in recent weeks. And recognizing Nigeria’s threat to the integrity of the OPEC deal, OPEC officials have suggested that Nigeria could lose its exemption status if the cartel extends the deal for another six months.

Nevertheless, about midway through OPEC’s six-month deal, the headlines about success are belied by a much more measured impact on supply fundamentals. The bottom line is that OPEC has only taken a few hundred thousand barrels per day off the market from last summer’s levels.

And those barrels from the Middle East are quickly being replaced by barrels from Texas. U.S. oil production is closing in on 9.1 mb/d, up about 600,000 bpd from last summer. After largely ignoring this growing threat, hedge funds and other money managers have suddenly grown more concerned as bloated inventories continue to rise, and a liquidation of net-long bets could be underway. Bullish bets are now at a one-month low and could be heading down. That helped spark a sharp correction in oil prices last week, down about 9 percent in a few days.

In short, the OPEC deal was kind of weak to begin with, and now U.S. shale could be killing off the OPEC-fueled oil price rally.

What happens next is uncertain. The much faster return of U.S. shale production and soft oil prices have sparked a growing chorus within OPEC to extend the six-month deal until the end of the year. This week Kuwait became the first member to officially endorse a roll-over of the production cuts for another six months. “Kuwait supports the extension of the agreement after June,” oil minister Issam Almarzooq said, a move that will ‘‘accelerate the rebalancing of the global oil market and will contribute to the return of prices to levels acceptable for producing countries and for the petroleum industry in general.”

Iraq and Angola have also suggested they would be open to an extension. The all-important Saudi energy minister has not endorsed such a move yet, but has shown more willingness to consider the move recently.

But the rebound in shale can cut both ways on OPEC’s calculations. For OPEC to sacrifice more of their production only to see shale producers quickly fill the void hardly inspires confidence. Ceding market share while only marginally boosting prices is not what OPEC had in mind when it agreed to cut output. The longer the cuts drag on without further price gains, the more likely members will grow tired of the arrangement. That increases the likelihood of cheating.

So while the shale rebound is pushing some within OPEC to consider an extension, Russia’s top oil company said the opposite dynamic might play out: a swift return of U.S. shale could lead to an unraveling of the OPEC deal altogether. “There are significant risks the (OPEC-led) deal won’t be extended partially because of the main participants, but also because of the output dynamics in the United States,” Russia’s state-owned company Rosneft told Reuters. “We think that in the long-term global oil demand dynamics and reduced investment during the period of ultra low prices will balance the market, but that the risk of a price war resuming remains.

In other words, the comeback of U.S. shale could not only kill off an extension of the OPEC cuts, but it could force all parties to once again engage in an all-out fight for market share, leading to another downturn in prices.

Print Friendly, PDF & Email


  1. nonsense factory

    The writing on the wall for the oil industry is pretty clear: (1) high oil prices are needed to finance recovery of the remaining dirty, hard-to-get oil, but (2) high oil prices drive a collapse in demand as consumers respond by turning to efficient technologies and renewable energy.

    The oil industry, from multinationals like Exxon to state actors like OPEC members, is thus trying to keep prices in a narrow band that is just high enough to make things like fracking and shale oil profitable, but not so high as to accelerate demand collapse. The highest-cost dirtiest oil is being abandoned, for example Exxon just wrote off tar sand oil holdings:

    The company said Wednesday in its annual 10-K filing to the Securities and Exchanges Commission that it has cut its estimate of recoverable reserves by a net 3.3 billion barrels of oil equivalent (or “bboe”), to just under 20 billion, a result of low crude prices that have made some of its investments in high-cost oil uneconomic to extract. Specifically, the company de-booked its entire pro rata 3.5 billion barrels of reserves in a Canadian oil sands project.

    Clearly the long-term picture is a shift to highly efficient vehicles (Toyota’s 133-mpg Prius just came out), electric vehicles, low-pollution fuels like natural gas for the trucking industry, etc. – meaning that gasoline and diesel are heading the same way as coal, slowly but surely. Smart investors should be unwinding their oil holdings as fast as possible.

    1. yamahog

      Toyota’s Prius Prime isn’t rated at 133 mpg on gas – it’s closer to 50-60 mpg and the Prius Prime is more expensive than the conventional prius. The primary benefit of the prius prime is that it has bigger batteries and ‘plug in’ capabilities. It goes 133 miles on the electricity equivalent of 1 gallon of gas but its batteries are so small that it can only go about 20 miles on electricity until it switches over to gas.

      Meanwhile, Toyota’s Camry (a 30 mpg car) is losing its sales volume to the Rav4 (a 24 mpg SUV). America’s desire for SUVs and AWD has resulted in a pretty constant fleet mpg average over the past two decades with gains in efficiency offset by gains in vehicle mass and capability.

      1. voislav

        I recently talked to somebody from Toyota and he mentioned that their production mix in North America is skewed compared to their demand. Their production mix 45:55 passenger cars to trucks/SUV’s right now, but the demand is 40:60 and it’s shifting further to the heavy side, they expect this year to be 35:65.

        This is despite heavy promotions and discounts they are doing on smaller vehicles to try to get them off the lot. On the truck side, they sell them as soon as they are out of the factory. Cheap oil is driving the demand for larger vehicles and killing the hybrid/electric sales.

      2. photosymbiosis

        The basic issue is that electric motors approach 99% efficiency at converting stored electric charge to power, while gasoline and diesel internal combustion engines tend to operate at 15-25% efficiency when converting gasoline or diesel to power. At current fuel & electricity prices, costs per-mile are at least 3 times higher for fossil fueled vehicles vs. electric vehicles.

        Hence, if oil prices rise to a level that makes production of the remaining oil profitable, fuel prices will also rise, driving that cost differential even higher in favor of electric vehicles. This is a fairly slow process, sure, but the trend is clear:

        What effect would a 10% drop in demand for gasoline and diesel have on crude oil prices? And at those low prices, what would be the effect on investment in exploration and production of oil? That’s the downward death spiral for the fossil fuel industry.

        1. nikbez

          “The basic issue is that electric motors approach 99% efficiency at converting stored electric charge to power,”

          This is not true. Electric motor in cars works via transmission, not directly because they rotate at higher speeds then is necessary to rotate the wheels.

          Which impose at least 20% losses.

          Battery also impose 10% losses as it has internal impedance and conversion of chemical energy into electrical and vise versa in not 100% efficient.

          Efficiency of the battery drops with age and three year battery is even less efficient. Another 5% losses are in charging devices and transmission.

          Add to this that electrical car needs to heat cabin with 5 KW heater or cool it with 3 KW air conditioner and outside California hybrids beat electrical vehicle to the punch in all important technological parameters.

          That means that electrical car right now is more of a status symbol, then a practical solution for regular folks.

        2. TOM

          Electricity is still mostly being produced by fossil fuel. If you factor in distribution loss and the much higher energy cost for producing batteries electric cars are less efficient. That is unless you take to producing electrity from renewables. But the renewables are not always on line and therefore you need to have the same amount of legacy power stations as before. You need to find a way to store energy but we are still very far from that and I personally don´t think we will ever return to the days when one unit of energy yields 100 units of energy in oil. Renewables will never provide these kinds of yields. And it isn´t at all clear to me why one had to move one ton of iron to get somebody from A to B. It is all in the mind….

        3. Synoia

          The basic issue is that electric motors approach 99% efficiency at converting stored electric charge to power.

          Not at all:

          Second law of thermodynamics applies, and maximum theoretical efficiency is 50%

          In the electrical world this is known as the maximum power theorem. Half the energy is consumed by the load (electric motor in the case) and half as heat in the source (the batteries in this case).

          1. nonsense factory

            You are confusing cyclic heat engines (max efficiency 55%) and electric motors (approaching 99% efficient):

            For typical gasoline engines and electric-power generating turbines, the second law of thermodynamics gives theoretical maximum efficiency of around 55 percent. For electrical generators, typical efficiencies are approximately 42 percent for natural-gas burning plants but only around 33 percent for coal burning plants…

            The energy efficiency of cars is much worse than for electric power plants. Automobiles driven in the city have energy efficiencies of about 15 percent, owing to additional energy losses not associated with the second law of thermodynamics…

            Though gasoline and diesel engines waste the majority of the energy in the petroleum that powers them, commercial electric motors can be more than 99 percent energy efficient. Furthermore, electric motors do not themselves emit smoke, soot or chemical emissions.”

            Source: The Energy Revolution (2015) by Harvard physicist Mara Prentiss.

      3. FluffytheObeseCat

        Quite a bit of the enduring switch to larger, lower mpg vehicles seems to be fueled by lending practices that favor big-ticket big machines. Absent this market-distorting ‘push’ from car manufacturers’ affiliated finance arms….. this preference might disappear. From the user perspective there are benefits to owning larger vehicles, but on our increasingly congested roads there are obvious drawbacks as well.

        You are – implicitly – claiming consumers naturally prefer the big vehicles that are pushed on them by financing gimmicks. I see the almighty consumer as being gamed on this matter.

        1. tongorad

          You are – implicitly – claiming consumers naturally prefer the big vehicles that are pushed on them by financing gimmicks.

          Where I live in TX, a mega-truck seems to an entree into machismo-ville, duck-dynasty utopia or somesuch. Amerika’s car culture looms large.

          1. johnnygl

            There are definitely regional and cultural differences that you are correct to point out, and status symbols corresponding.

            I think there are generational differences, also. Young people are much less into cars than the older crowd. Plus they prefer cities more, where cars become more of a hassle.

            With rising default rates and rising interest rates, the auto lending sector looks set to take a bath in the next year or two.

          2. Code Name D

            If you are going to be stuck in trafic for hours on end, with the kids in the back seat, would you rather be in a closterfobic combac or a spatious SUV?

          3. nick

            In MA I see a ton of shiny, otherwise normal looking pickups with commercial plates. I’ve always assumed it was tradesmen or plowers who could plausibly claim a tax break for these vehicles.

  2. RenoDino

    Peak oil consumption equals stranded resource. The race is on to pump as much as possible before demand dries up even more and prices collapse to $10 p/b. There is so much debt leverage against oil in the ground that pumping must be ramped to pay it off making a price collapse even more certain.

    1. likbez

      I wish we live in such a comfortable Universe as you describe. But this is a Utopia. In reality:

      1. There no peak oil consumption on the horizon world wide. Mankind adds around one million barrels per day in consumption each year. China and India consumption is growing and probably will continue to grow for at least a decade. Consumption in other Africa and Asian countries is growing too.

      2. There are very few oil fields were you can profitably extract oil at prices below $50 per barrel. And those fields are old and are closer and closer to depletion (those fields are mainly KSA, Iraq and other Gulf fields). Neither US shale nor Canadian oil sands belong to this category. But with oil prices above 60 or 70 the US economy will stagnate, unless supported by printing money. See nonsense factory post above. This is a new Catch 22 but will pretty menacing implications.

      3. Junk bonds generated by shale companies in the USA is a bubble (or Ponzi finance in Minsky classification, if you like) that will eventually collapse/deflate. Few bondholders will ever be paid.

  3. Tomonthebeach

    Countries like Russia and Venezuela that are running autocratic regimes depend on oil to pay for the social programs (aka freebies) that keep them in power. There is no way such countries want to slow production of oil – their political livelihoods depend on oil income – lower prices mean increased production.

    By the time Trump’s cavalry fends off the indians and gets the Canadian oil pipelines finished, their owners might have to scramble for customers.

  4. ewmayer

    So now we know why “Citi Tells Investors to Stop Worrying and Learn to Love Oil” (Bloomberg piece in yesterday’s Links) — they got a bunch of long positions they need to unload on the greater fools, erm, I mean on their clients.

Comments are closed.