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OPEC Fights Market, Extends Production Cuts

posted onAugust 21, 2017
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A sense of déjà vu pervaded the latest meeting of oil exporting countries. While production cuts have again bolstered oil prices, the optimism may fade, as shale producers in the United States jump back into the market and the rise of renewables dims prospects for demand.

The Organization of the Petroleum Exporting Countries extended oil production cuts through March 2018, after a meeting in Vienna on Thursday. The move follows a decision this month by Saudi Arabia and Russia to do so.

The earlier announcement helped lift prices from a low of $46. But on Thursday, prices slipped nearly 4 percent, to around $53.

Brent crude, the main international benchmark, has been trading around $ a barrel.

The American benchmark was at around $ a barrel.

Why oil prices have fluctuated so much in recent years »

The markets followed a similar path in September, when OPEC, with Russia and other nations, initially outlined plans for reductions. When the euphoria faded, prices slumped.

“OPEC is being caught in a pincer movement of technology and policy that will, over time, erode oil use,” said Bill Farren-Price, chief executive of Petroleum Policy Intelligence, an advisory firm for hedge funds and other investors. “This meeting is more about forestalling an oil price collapse than driving prices higher.”

Here are some factors muting the impact of the cuts to output.

The Shale Boom

Oil prices that topped $100 a barrel as recently as 2014 may have helped plant the seeds that are now weakening OPEC.

Back then, companies in the United States took advantage of the high prices, learning to produce huge quantities of oil from shale rock in a process called hydraulic fracturing, or fracking. The technique, which involves extracting energy by drilling long horizontal wells, then loosening oil from the rock, has transformed the United States into what is known as a swing producer, able to adjust production rapidly to match changes in the market.

But fracking has required substantial investment. When oil prices plummeted in 2015 and 2016, output from shale in the United States fell about 900,000 barrels a day, equivalent to almost 1 percent of the global supply.

The American shale industry today, however, is far more efficient. And unlike in previous years, it has an array of sources of capital to finance the drilling of new wells, including advance sales of oil, bank and private loans, and high-yield bonds.

When prices are down, that money dries up. But when prices tick up around $52 a barrel, activity ramps up quickly, according to Roger Diwan, a vice president at IHS Financial Services, which advises investors.

Khalid A. al-Falih, the Saudi energy minister, said on Thursday that he foresaw a healthy comeback for American shale production, but he played down its effect on OPEC’s efforts.

Still, the bloc’s biggest worry is such a revival, presenting it with a thorny problem as it considers its own market moves.

“The higher the price goes, the more shale operators accelerate production, and the more OPEC has to cut,” said Mr. Diwan, who forecast that United States shale operators would increase their output by about 900,000 barrels a day this year, soaking up much of OPEC’s production cuts.

The Electric Engine

A few years ago, high energy prices were sustained by a belief that the supply of oil was reaching a peak, but demand — driven by fast-growing economies like China and India — would keep rising.

The trends are shifting, and fast. Not only does there seem to be a major new source of oil from shale, but growth in demand is slowing.

In particular, the increasing number of electric vehicles is playing a role in limiting demand for oil. Their impact may grow with the development of cars run by computers.

“Everything is gradually going digital and everything digital is effectively electric,” Dieter Helm, a professor of energy policy at the University of Oxford, wrote in a recent commentary. “Transport will not escape this trend.”

Mr. Helm, the author of a new book, “Burn Out,” on the decline of fossil fuels, argues that, given oil’s uncertain future, $50 a barrel could turn out to be a “very high” price.

Even some big oil companies are accepting the view that demand for fossil fuels may soon decline.

In its Energy Outlook 2017, BP said that if the rise of alternative fuel vehicles, improved fuel efficiency and other trends accelerated more than expected, demand for oil might peak as early as 2035.

OPEC seems finally to be paying attention, too. Mr. Falih said on Thursday that the bloc needed to better understand the impact the 2015 Paris deal on climate change would have on oil demand.

An Erosion of Clout

In decades past, an OPEC decision to curb or increase production had wide consequences and would move markets.

That is no longer the case.

“OPEC has used Band-Aids to get through crises of the moment,” said Bhushan Bahree, an OPEC analyst at the research firm IHS Energy. “It’s not clear they are willing or able to address the larger issues of the global market.”

With that in mind, Saudi Arabia, OPEC’s de facto leader, brought in Russia and other producers outside the cartel to lend clout to the recent production cuts. Riyadh has also suggested changes to OPEC’s internal management, pushing the organization to better cooperate with other producers. OPEC, Mr. Falih said, “needs to evolve” and needs to “be part of the debate, rather than simply reacting to what is going on.”

On Thursday, the bloc announced that Equatorial Guinea, one of Africa’s largest producers, had joined OPEC, becoming its 14th member.

But presenting a united front with such a variety of players has proved complex.

Disunity already has occurred within the bloc. Member countries like Iraq and Iran contend they are entitled to higher production because of years of revenue lost to conflict and sanctions, and will probably press for increases to their output allocations.

A disconnect exists between the announced level of the cuts and the actual reductions.

Knowing that cuts were on the horizon, OPEC members increased production before they were made, which meant they were starting from an artificially high base. Several members have also been selling from their stockpiles of crude, blunting the impact of the reductions.

IHS Markit, for instance, estimates that OPEC countries trimmed output by 1.1 million barrels a day in the first quarter of 2017, but exports fell by only 900,000 barrels a day.

Signs suggest that the oil glut is easing, but its persistence has undermined OPEC’s ability to affect the markets.

Via [NYT]