This is the second part of a three part series discussing the recent past and future of oil prices and the reasons why prices are where they are. Many intelligent people who make their living analyzing oil markets have pointed to OPEC and its ability to enact large scale production cuts as central controlling oil prices. While this has yet to occur as the production cuts enter their fifth month true believers continue to chant the mantra “just give it time”.
Oil market analysts have long held that the market is over supplied and reduced production is needed. The difficulty with this is producers simply don’t appear to listening and instead continue to do what they regard as in their best interests and ramp up drilling and production levels. New technology has made production cheaper and allows for profits to be made in oil shale and oil sands while prices are in the range of $40-$55 a barrel. This brings the question: Why stop now?
Last month analysts from Credit Suisse agreed that both the Atlantic Basin and Asia-Pacific crude markets were overstocked. This is demonstrated by the widening price discounts seen for Asian grades such as the Russian ESPO blend and Qatar’s Al-Shaheen. The source of this global supply glut is not one single factor but a multitude of suppliers. These range from constantly increasing supplies provided from U.S. shale to OPEC member Libya’s stated goal of more than doubling last months production levels by August to 1.1 million barrels per day.
Futures traders focused solely on the desire for prices to rise are searching desperately for a reason for prices to rise and have been pointing at everything to justify a rally. Reasons abound, from allegedly high OPEC compliance, to expected seasonal rises in demand, to stagnating Iranian exports but to little avail. Markets have pushed lower in recent weeks and the reason is not hard to identify.
Statements are one thing but actions are quite another. In their rhetoric Saudi Arabia is leading OPEC in the move toward production cuts. However, this may be a case of “do as I say and not as I do” in that the Saudis seem reluctant to cede any actual market share. For example, last month the kingdom announced they would be cutting official selling prices to buyers in Europe and Asia. This is a move directed toward gaining market share not ceding it and takes place in Russia’s backyard where Iran has been looking to sign more long term contracts.
Speaking of the desire to retain valuable markets take the case of Saudi imports to the United States. Saudi oil imports to the United States are near the same levels they were last November when OPEC production cuts were announced. It seems that while Saudi Arabia may well desire prices increase, the idea of causing long term damage to their own economic relationships in the process is far less palatable.
This demonstrates perfectly the difficulty with production cuts and reflects a common trend from micro to macro economics. What is good for the market is often bad for the individual. Individuals may act against their own self interests but nation states are more rational entities and convincing nations to continue to act against their own interests is a hard sell indeed.