By Nigel Looi
It has been an interesting year for oil. At the start of the year, oil prices show sign of recovery spurred on by two main reasons. Firstly, the prospect of Organization of the Petroleum Exporting Countries (OPEC) agreeing to cut supplies gave investors the confidence that prices will soar. Secondly, due to weak US Gross Domestic Product growth data, the Federal Reserve had deferred thoughts of an early rate hike at the start of the year, which helped to establish a firmer stock market to support growth in oil prices. As a result, Brent Crude Oil prices grew from a low of 27.32USD to a high of 52.43USD per barrel. However, this bullish trend died out and prices stagnated from June 2016, fluctuating between 40USD and 50USD.
Late September, OPEC members met to discuss on the future of oil production within the cartel. At the end of the meeting, an agreement was reached and OPEC had finally decided to cut outputs by 700,000 barrels a day. According to IEA estimates, the glut crisis would be resolved by the end of the year. Consequently, prices of oil soared by 5% from 45.97USD to 48.69USD.
On 10 October, Russia made a statement saying that they are ready to limit their output on oil. Being the largest non-OPEC oil producer (11.1 Million barrels a day), agreeing to freeze or cut production will definitely help to stabilize the supply side of the oil market. This prospect has pushed the prices to 53.31USD, above this year’s previous hight in early June.
Figure 2 : Brent Crude oil day chart for the past 4 months
I believe that the effectiveness of this oil production cut would not be substantial.
First, overproduction of oil was initiated as a declaration of a price war against shale industry. Relevant figures have shown that approximately 50% of the shale gas industry have a breakeven cost, which is above 60USD per barrel. Therefore, to maintain this predatory pricing advantage OPEC has to carefully balance its outputs. Once the prices of oil increase, the shale gas industry would raise their outputs and dilute the effects of the production cuts.
Secondly, though Russia is currently ready to limit their production, there are still too many details, which have to be finalized. What is the limit on production? Will export of oils be capped at a limit? What would the repercussions be if a country does not follow the agreement? All this information would play a key role in determining the supply of oil in the economy. If these details are overlooked, chances are that the oversupply of oil in the economy would not be resolved even if a production freeze was implemented. Furthermore, IEA reported that expected oil demands grow at an alarmingly slower pace. If this persists, the production cuts of OPEC with or without Russia might not be adequate to drive oil prices back to previous highs.
Hence in my perspective, rise of oil prices would only be momentary and prices would not be able to hit above the $60 USD price ceiling.