Faced with a significant drop in crude prices, OPEC+ recently announced it would be extending existing oil production cuts. Although the move was somewhat expected, the degree of cuts certainly wasn’t–and its long-term effects remain to be seen.
What did OPEC+ do?
Leading up to OPEC+’s announcement, there was a lot of discussion about what they were going to do. Everybody was looking for them to maintain the existing output cuts of 3.66 MMbbl/d. Then when it became clear that OPEC+ likely would further react to lower oil prices, a lot of people in the industry expected additional bbl/d cuts to be anywhere from a quarter-million to a half-million bbl/d.
Instead, OPEC+ decided to cut production by 1 MMbbl/d. That obviously caught the market by surprise. However, one of the bigger elements of their announcement to keep production levels in place to the end of 2024, which I believe has just as much significance to oil pricing as the cuts do.
So, what’s going on?
Well, OPEC+ is very, very sensitive to price levels. Candidly, I think $60/bbl is too low and $90 is too high–and if prices drop below $60/bbl, I think you’re going to see them continue to react.
However, the more significant issue is that we’ve seen a structural change. The Baker Hughes rig count marked a loss of another 15 rigs in the first week of June. That’s one sign that higher interest rates and inflation are making an impact, as these factors are increasing the cost of production and moving break-even prices higher–and keep in mind that rates are expected to move higher this year. Basically, the higher the interest rates and the lower the crude prices, the more drilling rigs we will see disappear.
On the flipside, I think Russia is continuing to produce well over what they’re stating. Although they’re saying that the fuel that’s coming into the market is old inventory and that supplies are depleting, a lot of people, myself included, don’t fully believe that. Rather, we think they’re going to continue to produce, which would offset some of OPEC+’s cuts.
What’s the long-term impact?
The long-term impact of these macroeconomic factors will have a lot to do with demand. There was record travel over Memorial Day weekend, so demand is coming back–just at a slower pace globally than we all hoped for.
The fact that Russia is selling fuel to the world in a discounted market, under normal market conditions, takes the U.S. and other countries out of pricing.
But in the long term, despite rig counts dropping, I don’t see global demand falling as well. Instead, I foresee demand either continuing at current levels or maybe even clicking a little higher. Plus, if Russia starts to play ball and participates with cuts in production, we could see some higher prices, which is what it will take to get the rig count to really move higher and the Permian and shale producers excited again. After all, they want to see that upper-$70 or lower-$80 market back into the curve.
That said, I think crude in the $90 range hurts the world economy. Could we go there for a little while? Sure, but I don’t think we can maintain it.
What about refilling the Strategic Petroleum Reserve (SPR)?
Finally, as prices have fallen, there has been some discussion about the U.S. refilling its Strategic Petroleum Reserve (SPR) and whether or not it would put a floor under crude. We’re definitely going to have to refill it, even though we’ve had the chance to do so at lower prices than this and it did not happen.
So, why now? The SPR is at a 40-plus year low, therefore the need to refill it is growing more important to the American public. Since near-term global demand remains below expectations, the timing could be right this time around to begin the refilling process whenever prices dip.
If the SPR does move onto a refilling mode, I think it does put a floor under oil prices. Unless there is an economic collapse–and I don’t foresee that happening–anywhere in the low-$60/bbl area could be a very fine floor. Some banks still predict Brent crude to be in the $90 to $100 range, but that seems unlikely. Instead, it’s more likely that Brent will move into the $80 range for a little while–and that’s what it will take to move OPEC+ back into more production. One thing is for sure, look for volatility in prices to remain in the third and fourth quarters this year.
Dennis Kissler is senior vice president of trading at BOK Financial Securities. He is based in Oklahoma City.
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