WTI Oil prices breached $30/bbl on the downside in February’16 when OPEC declined to cut production despite a slide in prices seen earlier. Saudi Arabia’s Oil Minister Ali al-Naimi who uttered phrases such as, “whether it goes down to $20, $40, $50, $60, it is irrelevant,” certainly did not help the market back then either. Doomsday articles were published calling for Oil to break $20/bbl even. At that time OPEC (Saudi Arabia) did not fully understand the dynamics of Shale oil production and took a gamble on their projected path. Their strategy to focus on defending market share rather than support prices was aimed at “purging” US shale. To their detriment, US production recovered after a brief drop; their plan back-fired whilst their foreign reserves dwindled further.
Over the past three years, Saudi foreign reserves have dropped by a third from a peak of more than $730 billion in 2014. In November’16, OPEC concocted a plan and garnered group support to sign off on an Oil production cut of 1.2 million barrels per day. Oil prices rose 10% on the day even though the cut was more about optics than an actual cut given the ramp up of production from the key members going into the cut itself. Rightly so, Iran was to be excluded from the cuts as they exited their sanctions. The stabilisation of Oil prices between $50-$60/bbl. was meant to curb the slide in Saudi reserves but in April’17, Saudi Arabia’s central bank reported that their assets fell to $493 billion (lowest in six years) despite austerity measures taken last year.
Leaving the recovery of Libya an Nigeria aside for a moment, it was the fast return of US Shale that blind sided OPEC as they underestimated the recovery potential of US shale producers. The Permian wells survived in $46/bbl. WTI even! This begs the question at what price level do global inventories start to rebalance in reality?
Global oil demand has been losing momentum in 1H’17, and increased just 900,000 barrels per day in Q1’17 vs. 1.6 million barrels per day in Q1’16! This was due to a combination of cyclical factors and some secular trends (rotation into LPG, liquid petroleum gases, out of gasoline and diesel). OECD total oil inventories are still above 3 billion barrels. Only two things can help rebalance the market; lower supply or higher demand. With the latter not showing any signs of acceleration especially as we move into a tighter monetary policy environment going forward, the onus is on the former. For supply to fall, prices need to fall to a level whereby the marginal swing producer can no longer survive and be profitable. That means prices needed to fall below $45/bbl. WTI and tread there for a while, to force that excess supply out of the market.
The risk reward looks a lot more compelling now especially as the rig count data plateaus and E&P producers feel the pinch of lower Oil prices. Dare i say it, could the Oil market actually be bottoming out now after all the Hedgies have thrown the towel in?