For the last few days, oil prices have been trading in a very narrow range between $42 and $45 a barrel. They won’t be staying there for long.
You see, there are two factors keeping prices locked in that range. One is short-term, here in the U.S.
And it’s about to be removed today…
The other is OPEC’s long-term strategy to crowd out competing oil producers. Rumors would have you believe this will change before the end of the month, at the upcoming International Energy Forum (IEF) summit in Algiers.
That’s not going to happen…
Here’s when OPEC will change its strategy… and what the Algiers meeting is really about…
Oil Stockpiles Drive Down Oil Prices
These days, anything prompting a larger oil stockpile, no matter how small, will tend to lower oil prices.
For example, the recent closure of the Colonial Pipeline (which transports gasoline from Houston to New York) after a leak was discovered has increased surplus oil sitting at refineries, which decreases its price. And the resulting limited gasoline supply in the Northeast has driven up prices at the pump there.
This pipeline closure is reaching its end, as a new bypass should be in operation today.
And then there is the ongoing lack of balance between production and actual demand.
The “excess” production (both globally and in the U.S.) is something I’ve addressed on several occasions here in Oil & Energy Investor. The issue here is not the surplus but the balance.
Market stockpiles are essential to temper extreme volatility in pricing. Availability of raw materials as basic as crude oil should never be administered using a “just in time” delivery schedule.
That may work in some industries, where lowering stocks on hand is important in improving bottom lines. But crude oil and oil products act quite differently.
With them, any perceived constriction in supply will spike prices.
This is why Northeast gasoline prices moved up significantly in the wake of the pipeline closure and are now declining as a solution to the problem is in sight.
Of course, in the context of the balance between supply and demand, “supply” doesn’t mean what it used to…
Large Oil Reserves Make for Confused Pundits
For the past several years, the marker has had to wrestle with this new element, one that a few pundits continue to misunderstand: we now have much more extractable reserves in the ground than ever.
The result of massive shale and tight oil finds in the U.S., this new largess had little impact when oil prices were north of $100 a barrel. That’s because it was widely believed that OPEC would cut production to maintain prices, if necessary.
That belief came crashing down in late 2014 when Saudi Arabia led OPEC to changing its policy from defending prices to defending market share.
OPEC’s goal was to marginalize non-cartel production by forcing others to fend for survival in a declining price environment. But for countries that depend on oil revenues to sustain their central budgets, the result ended up being quite different from Saudi Arabia’s original intentions…
The Market is Now Focused on the Algiers Energy Summit
Unlike in a market with stable prices – where countries keep some oil in the ground to support the price of their other oil exports – there was now no reason not to pump and sell as much oil as possible.
Monthly extraction rates reached historically high levels and remained there much longer than any supply-demand dynamic justified.
Against this backdrop, calculating the impact of excess reserves becomes much more difficult. Certainly, their presence tempers any prolonged race back toward $100 a barrel. The oil price ceiling has definitely been lowered.
But just because there’s excess oil in the ground doesn’t mean it’s coming up. At any price below the low $60s per barrel, it is still too expensive to lift shale and tight oil.
In other words, the actual pressure these reserves put on crude prices depends on what those crude prices are.
And that’s why the market is now focused on the IEF ministerial meetings taking place in Algiers on September 26-28.
Now comments from the oil ministers of Venezuela and Algeria (both OPEC members) imply a deal to freeze or cap oil production will be agreed to in side-bar discussions in Algiers. Supporting statements have been made by Iran, another OPEC member, as well as Russia, the main non-OPEC centrally-controlled oil producer.
But no such agreement will be announced in Algiers.
In fact, that’s not even what OPEC and Russia are trying to accomplish…
OPEC’s “Open-Tap” Policy Will End – But Not in September
Instead, a consensus needs to emerge between OPEC on the one hand and Russia on the other over sustainable monthly production levels. Currently, both OPEC and non-OPEC policy is to produce as much as possible and move it to market as quickly as one can.
This “open-tap” approach leads directly to producers wrestling market share at the expense of others, and is accomplished by a complicated series of export pricing changes and discounts, especially targeting the expanding Asian market.
It’s a zero sum game with the winners changing from month to month and only then by effectively reducing realized revenue.
Back in April, a proposal was made at a meeting in Doha to cap production levels using January’s production figures. Those just happened to be the highest aggregate levels achieved in years.
Since then, production levels have actually climbed a bit as producers continue to shoot themselves in the foot. One effect has been monthly production levels that are difficult to sustain even for the top-tier of OPEC producers (Saudi Arabia, United Arab Emirates, Kuwait).
But this is a self-defeating approach, and all participants are looking for a way out.
However, ignore the rumblings about a breakthrough production cap during the Algiers IEF summit. Rather, the real consensus will emerge “off-camera.” Signals now suggest the announcement of a “special” OPEC meeting at its Secretariat in Vienna.
I expect that later this year.
In the meantime, OPEC will keep pumping oil as fast as possible. But don’t worry. That actually gives you an amazing opportunity to make money on the oil industry’s winners and losers, both. Click here for my full analysis.
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