The "call on US shale": Should OPEC be careful of what it wishes for?
Recent statements released by President Vladimir Putin and Saudi Oil Minister Khalid al-Falih, in addition to other senior OPEC ministers, indicate a pivot towards an alignment of interests.
Catalyzed by the Russia-OPEC meeting in Algiers on September 28, global crude pricing benchmarks rallied. Buoyed by a perception that the ‘tightening’ alliance are seeking crude production curbs, ICE Brent hit a one year summit, climbing three percent on Monday 10 October to over US$53/bbl. Looking forwards, the chances of a final agreement being signed at the OPEC meeting in Vienna on 30th November appear relatively high.
With front-month gas futures rising over 2 percent in early October, U.S. natural gas prices have ascended to their highest level for more than a year as the market adjusts to changing supply and demand fundamentals.
Since spring domestic production has plateaued in the U.S. while demand has been robust in the face of an exceptionally hot summer and low gas prices. As a result IEA data indicates diminishing stock builds throughout the injection season have blown away the substantial surplus of natural gas left over from the mild winter of 2015.
Against a back drop of easing production and the onset of a potentially cool winter, expect prices delivered to Henry Hub in 2017 to be significantly higher than the lagging prices that have shaped the market for much of 2016.
Following on from the Algiers meeting in late September, oil prices have surged above the psychological level of USD50/bbl, in what appears to be the first move into this higher-terrain that has persisted since mid-2015. Analysis of the potential Russian and Saudi Arabian agreement has, once again, attracted the bulls back into the market.
"With a highly-probable OPEC-Russian deal on the table, the likelihood of elevated crude oil prices seem all but confirmed. The recent unity demonstrated by the other OPEC members indicates that not only oil production freezes, but potentially a cut is becoming increasingly possible.
It is no secret that many of the OPEC countries have experienced increasing economic difficulty ever since the November 2015 meeting in which they decided not to adjust high production output. A moderate production cut at this year’s upcoming November meeting in Vienna may prove to be the fulcrum with which these member countries can push oil prices back up to USD60/bbl levels; providing them with breathing room. Their focus will be on US shale to see how quickly frackers return at those levels."
– Oliver Hsieh, Associate Director, Commodity & Energy Risk Management, KPMG in Singapore
In spite of doubts surrounding the practical implementation of the OPEC deal, the market is viewing the softening in Saudi Arabia’s stance as a limit to further downside for now, which is most realistically their true goal. However, in the event the OPEC cut were to materialize fully—which is not our base case—the most meaningful scenarios to consider would be the likely US shale responses at different potential OPEC production levels and the new “push/pull” dynamic that will characterize oil market fundamentals going forward. To that end, Eurasia Group has proactively forecasted the price outcomes around successful implementation of OPEC production restraint at either end of the production range target outlined in Algiers of 33-32.5 m/bpd. If OPEC limited its crude oil production to 33 m/bpd indefinitely, which would be approximately 500,000 bpd below our 2017 forecast, prices would need to increase to $60 (for WTI), to both curtail demand and increase supply. If OPEC cut crude oil supply to 32.5 m/bpd, which would constitute approximately 1 million barrels below our base case, we would need a price of approximately $65 to balance inventories by the end of 2018.
The US shale production response would ultimately flood the market and cap a move in 2017 at $65. Renewed OPEC efforts to control production would backfire as the strength of US productive capacity takes away any remaining market hope that OPEC can do anything more than limit price downside. Given our base case scenario of OPEC failing to build consensus, Eurasia Group maintains a 2017 WTI price forecast at $52.50, for now.
– Bruno Stanziale, Director of Commodity Strategy, Eurasia Group*
* Guest contributor to October edition
Note: The forecasts/analyst estimates identified are an indication based on third party sources and information. They do not represent the views of KPMG.