Why does an oil producer agree to reduce output and surrender market share at a time of lower prices? Only because a coordinated supply restraint holds the promise of raising prices enough to more than compensate for the reduction in income from lower sales volumes. That rationale disappeared this month. OPEC’s reference basket of crudes was almost $2/barrel higher in June than last November despite prices crashing to seven-month lows, but the collective takings of the 11 producers paring back output will be lower this month. The question now is, how long can producers live without the trade-off and maintain their compliance with a tough deal? If OPEC is once again waiting for the shale producers to blink, it could end up being a long wait. And that takes the market back to square one.
June will be leaving OPEC poorer by around $3.7 billion compared with May and shaving $5.7 billion off its crude’s value versus April.
Measured against December 2016, when the bloc pumped full-tilt while enjoying the anticipatory premium in crude prices resulting from its production cut deal, the coffers of the 11 OPEC members restraining output would be about $7.9 billion short this month.
OPEC’s “reference basket” of crudes, which comprises the daily prices of 14 grades broadly representative of its members’ production, averaged $45.19/barrel over June 1-29, down from $49.20 in May and $51.67 in December.
The June basket price is still above the $43.22 average of last November, before the historic output cut deal, but the producers’ overall takings have shrunk, thanks to their reduced supplies.
The precise values of the oil produced would need to take into account all the OPEC members’ crudes and respective volumes in addition to their official selling prices (OSPs) or spot market prices.
We are using a back-of-the-envelope calculation with the basket price as a proxy to illustrate that the lynchpin of the OPEC/non-OPEC cuts has fallen off. Crude’s latest tailspin to new seven-month lows has eliminated the price gains that were meant to more than offset lower production volumes and yield higher revenues for the participating countries in the long run. The most obvious rationale for any producer to sign up for restraining output and sticking to its pledge is gone.
Crude was in correction mode this week, and on course for an eighth straight day of gains Friday in Asia. But the price recovery has been modest compared with the pounding of recent weeks, and is characteristic of short-covering and bargain hunting buying, rather than a shift in fundamentals, which are still firmly pointing to a supply glut.
We said last week that OPEC needs to respond and deepen its cuts. It appears to have decided to risk playing the waiting game.
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Headline crude prices for the week beginning 12 November 2018 – Brent: US$71/b; WTI: US$60/b
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