OPEC Strategy Bears Fruit As Oil Prices Break Out

OPEC embarked upon a disastrous strategy in 2014 when it decided to defend market share against U.S. shale oil producers, but its new strategy is having the desired effect on the oil markets.

In late 2016 OPEC engineered significant oil production cuts in order to address an oversupplied oil market. Global crude oil inventories had reached record highs, and the price of oil had crashed following a disastrous decision by the cartel in 2014 to defend market share.

In contrast to the 2014 decision, this time OPEC’s strategy is having the desired effect. Over the past year, despite strong U.S. shale production growth, global inventories have steadily declined. According to the latest Oil Market Report from the International Energy Agency, supply is expected to lag demand for the rest of 2018, further depleting inventories:

Demand/Supply balance through 2018.

In response to declining inventories, global oil prices have steadily increased, breaking through three-year highs last week and again this week. West Texas Intermediate closed last week above $67/bbl, while Brent closed above $72/bbl. These prices are approximately 50% higher than they were last August.

The latest bullish news for oil prices was a weekly report from the Energy Information Administration (EIA) showing another 1.1 million barrel drop in U.S. crude oil inventories. This now moves crude oil inventories down into the lower half of the range for this time of year.

But in addition to the drop in crude oil inventories, the EIA also reported that gasoline and diesel inventories each dropped by at least 3.0 million barrels last week, bringing the total drop in commercial inventories to 10.6 million barrels for the week. That’s an unusually large (and bullish) draw on inventories.

Meanwhile, last week last week Bloomberg reported that Saudi Arabia (OPEC’s leading producer) has its sights set on a target of $80/bbl. This week Reuters reported that the target could be as high as $100/bbl.

Given that Saudi Aramco is the single largest producer of oil in the world — with the power to move oil prices — this target should be taken seriously. Despite the disastrous price war on shale producers, Saudi Arabia usually achieves its aims in the oil markets.

However, $100/bbl would stimulate significant investment in U.S. shale production, which backfired the last time oil prices were at that level. But this is a clear indication that Saudi Arabia isn’t going to abandon the production cuts any time soon.

As I have noted in the past, once Saudi Arabia embarks upon a strategy, it usually sticks with that strategy for an extended period of time. Especially when that strategy is having the desired impact.

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One thought on “OPEC Strategy Bears Fruit As Oil Prices Break Out”

  1. I think $100 will be hard to sustain. It won’t just be US growth but other countries, offshore, etc. if there is the prospect of $100+ oil. In addition, demand would take a hit (or grow much slower).

    The current runup has been helped by the collapse of Venezuela, but there is a limit to how much it can drop. I would not just say it is an OPEC/SA success (although certainly the deal helped).

    Going forward, the strip is down. Of course anything can happen. But the betting market line is down, not up.


    (to nearest half dollar)
    MAY18 (prompt): $68
    DEC18: $65
    DEC19: $59
    DEC20: $55
    DEC21: $52.5
    DEC22: $51.5
    DEC23: $50.5
    DEC24: $51
    DEC25: $51.5
    DEC26: $52

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