Cleartrade Exchange Pte : Oil Commentary

12 January 2017
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The Return of the US Oil Could Possibly Slow Recovery

With a surge of more than 40 percent at the end of the year, 2016 was indeed a spectacular year for the oil market. One thing that's for sure is that the first agreement in almost 15 years among the major oil producers has raised the market's hopes of a rebalance between supply and demand in the coming year. Optimism across the market in late 2016 lifted oil prices in spite of analysts' warning that the supply cut is still insufficient to remove the excess supply. Regardless, the oil deal is certainly positive for the market, at least for the first half of 2017.

Although the oil deal will only start in January 2017, total OPEC output dropped sharply by 3 percent to 33.1 million barrels per day (bpd) in December, the largest monthly fall since February 2009. Since OPEC members have a bad history of not adhering to their quotas, Russia said that they would only follow the agreement if OPEC does. As of the second week of the year, it seems that these oil producers are serious about the cut in a bid to lift oil prices. This does not appear to be as surprising now given that they have been suffering economically with the decline in revenues and cuts in spending by the governments.

The need for higher oil prices is at its peak and the cartel had to stop its price war. According to Kuwait's OPEC governor Nawal Al-Fezaia, Qatar, Kuwait, Oman, Saudi Arabia and United Arab Emirates have started working towards the production cuts as agreed, hence making the deal more promising. If all goes well, total OPEC production is expected to approximate 31.238 million bpd in January, with the cartel reducing output by around 1.166 million bpd. However, the focus has been on Iraq as its oil exports from the southern ports have hit a record of 3.51 million bpd. Despite the rise in oil shipments, its oil minister Jabar Ali al-Luaibi affirmed that they would comply to its 210,000 bpd output cut by the end of this month. Nonetheless, this has certainly lowered optimism as Iraq might be the first to break the deal.

One of the market's concerns is the return of the US oil. Data for both its oil rigs and inventories reflect slightly negative impact on the oil market. The US oil industry suffered a huge setback, especially in late 2015 when prices reached an all-time low and unprofitable level. The period of weak prices witnessed the exit and bankruptcy of numerous oil companies, as well as the loss of jobs across the energy market.

According to Baker Hughes, oil rig counts were on a downward trend since 2015 before it reversed direction in June 2016. Oil rig counts are at 529 in the week ending 6th January, its 10th consecutive weekly increase. This is almost 70 percent higher than its lowest rig count recorded in mid-2016, reflecting the breakeven level for these shale producers. Oil output from the US has also been on the rise in the last 3 months. Also, the rate at which North American oil and gas producers have been filing for bankruptcy has been slowing down. According to data tracked by Haynes and Boone, the number of oil and gas producers who declared bankruptcy were at its highest level in May 2016, which then slowed down subsequently.

Reopening of oil rigs, increasing production and lower exits from the market indicate the improvement in the US energy market from rising oil prices, boosted by the oil deal. According to US jobs data released on Friday, jobs in the US oil and natural gas industry increased in November, the first rise in more than 2 years. The rebound in oil prices has definitely lifted the oil market in the US.

If oil prices were to continue rising, making it profitable for more US shale oil producers to restart drilling, the output cuts by OPEC and Russia might have limited effect for balancing the supply and demand. Given that the planned output cuts and forecasted global demand growth are already insufficient to remove all of the existing oversupply, additional pressure from rising US oil production will unquestionably slow the recovery.

In the short-term, oil prices will likely improve in comparison to the depressed levels over the last 2 years. This will be further supported by the effects of seasonal demand increases. For instance, as reported by the US EIA, refineries in the US are currently operating at its highest run rate since September last year. But the question is whether these increases would be sustainable in the longer term. Additionally, this oil deal will only hold for a 6-month period with no indication if it would be extended or renegotiated.

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