Oil traders largely expect the Organization of the Petroleum Exporting Countries to agree later this month to extend a production-cut agreement into the second half of 2017, but at least one analyst is very skeptical.
After all, the “current strategy is not working,” Nitesh Shah, commodity strategist at ETF Securities, wrote in a blog post Thursday.
He said that the most “credible options” for OPEC’s next move would be to either agree on a deeper cut or let the deal collapse. “The latter options seems the most likely outcome.”
OPEC members and some major non-OPEC oil producers agreed to reduce their collective output by 1.8 million barrels a day under a six-month agreement that began on Jan. 1.That pact is set to expire in June and OPEC is expected to make a decision on whether to extend it when members meet in Vienna on May 25.
Strong compliance with the cuts helped oil prices
climb in February to their highest levels since the summer of 2015 but year-to-date, they have lost roughly 10%.
“The efforts of OPEC members with assigned quotas are being undermined” by growth in supply from OPEC members who don’t have quotas, as well as non-OPEC members who are part of the deal but aren’t sticking to it, and “rapid growth in supply from other countries, most notably the U.S.,” said Shah.
U.S. crude-oil production climbed to 9.31 million barrels a day for the week ended May 5, up from 8.77 million barrels a day at the end of 2016, according to data from the Energy Information Administration.
Meanwhile, in a monthly report released Thursday, OPEC raised its forecast for 2017 oil-production growth from countries outside of OPEC by more than 60%.
OPEC “repeating the same strategy for another six months will do little to shore up oil prices,” Shah said.
“OPEC nations have given up market share and have barely reaped any price gains,” he said. “Given that consensus expectations are for a simple deal extension (i.e. that is what is currently priced-in), following the status quo is unlikely to be met with a positive price response.”
If OPEC is “serious about getting the market to balance, it will have to cut deeper in order to ‘shock’ the market and drive prices higher,” said Shah.
But it would be a difficult to reach an agreement on a “bolder move,” with the “smaller and more financially-constrained members reluctant to give up more volume,” he said.
And if the cartel can’t reach an agreement for a deeper cut, the “default option,” said Shah, would be to do nothing and let the deal collapse.
And that’s exactly what he believes will happen. The meeting this month is likely to “surprise on the downside with a lack of agreement,” he said.
Under that scenario, WTI oil prices could fall close to $40 a barrel, which he sees as the “structural floor for oil prices, set by the break-even price of U.S. shale-oil production.”