MARKETS Commodities

OPEC agreement, the path to success is still long

Year to date, the MSCI Energy is underperforming the MSCI World by more than 23%.

Despite the upward revisions in demand from the EIA, the barrel did not manage to break the USD 50 price due to mixed signals surrounding worldwide supply and demand. On one hand, the large decrease in US crude oil inventories, a decrease in rig count from 768 to 765 and the rise in demand for oil in the Middle East and China supported oil prices. On the other hand, a continuing growth in US oil production at its 2 years high of 9.50 Million barrels and declining investors’ confidence in the OPEC deal compliance continued to put downward pressure on the barrel.

Interesting to note that the spread between WTI and Brent hasn’t been so wide in 2 years reaching USD 4.21 on the 18 August. Because of oversupply in the US the WTI future curve is increasingly turning into Contango as buyers are willing to pay more for future delivery to avoid storage and insurance costs. For Brent, buyers wants sooner delivery, signalling a shortage and turning the future curve into backwardation for the first time in 3 years.

When OPEC and Russia decided on their strategy in November 2016, they expected it to succeed within 6 months; it now looks like it could take years. Apart from a political issue, too many events have to align in order for the OPEC strategy to succeed and reduce the oversupply in the short term: Lower US crude inventories, lower US shale production, higher compliance from the OPEC members, reduced output from Nigeria and Libya (not included the OPEC deal), and an increase or stabilization in demand. Any degradation in one of these factors, will delay the goal of the cartel to push global oil inventories below the 5-year average.

OPEC is meeting again on November 30 in Vienna to discuss whether to extend or end the oil-production-cut agreement. Unless political tensions in Libya and Venezuela continues to escalate and hinder crude oil supply, we believe that the path to success is still long and before we see US shale production diminishing, prices will not break significantly above the USD 50 barrier.

Pierre Melki - Equity Analyst Global Equity Research, Energy & Utilities - Union Bancaire Privèe (UBP)

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