Oil prices can fall below $40 due to global supply glut

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Oil prices can fall below $40 due to global supply glut
The US is pegged to produce 9.9 million barrels a day in 2018, the highest Uncle Sam ever produced.

dubai - The Opec made a strategic mistake exempting Libya and Nigeria from its output cuts

By Matein Khalid

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Published: Sun 20 Aug 2017, 8:46 PM

Last updated: Sun 20 Aug 2017, 10:49 PM

The latest Opec meeting in Abu Dhabi did not reassure global oil trading markets and energy stocks in Wall Street remain the S&P 500 index's worst-performing sector of 2017. In retrospect, the Saudi-Russian deal last November has failed to stabilise the market as Brent/West Texas crude prices are 20 per cent below 2017 peaks. The Opec made a strategic mistake exempting Libya and Nigeria from its output cuts as both countries have flooded the wet barrel (physical) crude market by more than one million barrels a day. Iraqi compliance to the Vienna deal has been a joke at only 30 per cent. Kazakhstan actually raised output since last November. US rig count has almost doubled since summer 2016 and the frackers of West Texas have produced 900,000 extra barrels a day since the Opec inked its historic deal in Vienna in November 2016. Saudi Arabia can no longer play the role of swing producer, the central bank of black gold it played in the Sheikh Yamani era, in the Age of Shale.

Even a 1.8 million barrel a day output cut by the Opec, plus Russia, and other global oil producers has been insufficient to rebalance the world crude oil market. The North Korean geopolitical crisis has cast a shadow on Asian oil demand growth while prices have now fallen to below post Vienna deal levels. In 2009, Saudi Arabia had engineered a "shock and awe" four million barrels a day Opec output cut, the biggest since Sheikh Abdullah Tariki and Juan Pablo Pérez Alfonzo founded the organisation in 1960. This was sufficient to lead to major rise in crude oil prices from a post-Lehman low of $38 in the global recession of 2009 to as high as $115 in June 2014, the month this millennium's most traumatic oil price crash began. The world needs a credible Saudi-brokered three million barrels a day oil cut and compliance by major producers like Iraq, Iran, Nigeria, Angola and Algeria. Global financial and political realities make such a "shock and awe" Opec deal impossible to negotiate and impossible to enforce. The result? The global supply glut worsens. Speculators continue to sell crude oil futures in the financial pits of London, New York, Chicago and Singapore - and Brent crude once again falls to $40 a barrel. The velocity of US shale oil production is simply beyond the control of the Opec, which barely supplies one-third of global crude. Compliance to last Vienna's output deal has been poor by some of the Opec's biggest producers, notably Iraq.

The Qatar crisis is yet another bearish data point for oil prices. It is only a matter of time before Saudi Arabia and Russia conclude that there is no point in bearing the disproportionate political and financial burden of the Vienna deal. That will be the point when crude oil prices collapse, possibly to February 2016 lows of $28 a barrel. Meanwhile, the rise in US land drilling rig counts and supply elasticity of production promises another surge in US shale output. The Energy Information Administration in Washington predicts the US will produce 9.9 million barrels a day in 2018, the highest Uncle Sam ever produced. This surge in American output in 2018 mean the odds of another oil price crash become almost certain and the strategy of relying on Saudi output cuts to stabilise the world oil market will no longer work.

In any case, US producers are programmed to hedge their output any times prices approach $50 in West Texas spot crude. Like gold in the 1990s, Pavlovian futures hedging by thousands of small producers almost guarantees a protracted bear market in crude oil. This is the reason why even the fall in US crude inventories has not been sufficient to boost prices in August. The surge in US gasoline storage is also an ominous sign as the US summer driving season is set to end after Labour Day in September. The collective net long position in West Texas crude oil futures could well unwind with a vengeance by October.

Non Opec output growth is another bearish data point for crude oil prices. The IEA's growth estimates for non-Opec output is 1.073 million barrels a day in 2017. The US, Canada and Brazil are all ramping up output after fire related outages were resolved. Russia and Kazakhstan, desperate for petrocurrency revenues, have both rejected deeper cuts. This increases the odds of another oil price crash.

The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com


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