Pressure on oil prices as spurt in US crude output may offset OPEC cuts

The world may well have to brace for a further decline in crude oil prices, thanks to the booming US output of shale oil following a steady increase in rig count in recent months. Higher US production is seen offsetting a significant part of the production cut agreed among major OPEC and non-OPEC producers, including Russia.

As the demand-supply fundamentals change in favour of higher supplies accentuated by burdensome inventories in the US, speculative interest in the energy commodity is beginning to wane. There has been a sell-off in crude since the beginning of this month. On the bourses, the speculative net length (non-commercial positions) is down by a third from the peak levels seen in mid-February.

The rig count is an important lead indicator of supplies, with a lag of about four months in supplies materialising. According to reports, since the beginning of this year, the number of rigs in the US rose from 529 to 703. Each rig has the potential to produce between 5,500 and 3,500 barrels a day depending on the productive efficiency of the rig and the promise of oil available. A conservative estimate is that US production could rise by 600,000 barrels a day four months from now or by the end of the third quarter. If this is added to the 880,000 barrels a day that the US has been producing since October 2016, it can substantially offset the production cut announced by OPEC and Russia.

Indeed, market participants wonder whether the rig count in the US will rise further. If it does, there will be additional output. The price implication of such a development is obvious.

The International Energy Agency (IEA) has indicated that the world oil supply-demand balance started rebalancing in the second quarter of 2016 after nine straight quarters of surpluses. A good portion of the new US oil production is starting to be offset by the OPEC/non-OPEC production restraint agreement, which removed 1.8 million barrels per day from the world oil supply chain.

However, any tightening of world oil supplies would require an increase in global oil demand to offset the rising level of US production or, in the alternative, a higher level of production cut outside the US. It is unclear if either of this will happen although there is talk of extending the period of production cut. However, there are sceptics who believe that any rally from production cuts may not last long as supplies would tend to catch up.

Global oil demand growth in 2017 is expected to stay positive and improve over 2016. The IEA has predicted a global demand growth of 1.3 million barrels a day this year, higher than in 2016. The positive correlation between economic growth and growth-driven consumption of commodities such as crude oil is well-known.

China and India, two of the world’s fastest-growing significant economies, continue to drive oil demand growth. According to reports, US crude oil exports to the two Asian economies are beginning to gather momentum.

Looking at the tug-of-war between demand growth and supply growth, crude prices may continue to stay in a consumer-friendly zone of $46-52 a barrel over the next quarter. Commodity markets move not on the basis of current demand-supply fundamentals, but on the basis of anticipated changes.

The anticipation in the months ahead is that demand growth may trail rapidly improving supplies. Even a small change in either demand or supply or both will exert a disproportionately larger impact on prices.

The writer is a Commodities and Agribusiness Specialist. Views are personal

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