Last week an announcement was made that suggested the possibility of an oil production cut through a coordinated effort between Russia and Saudi Arabia. The news helped boost the ruble by more than 10% and lifted oil prices along with it. The reduction would’ve helped bring an end to one of the largest oil surpluses we’ve ever seen.
However, the rumors are proving to be just that – only hearsay. Saudi Arabia has denied making any such comments, while Russia commented that its Foreign Ministry was attempting to reach out to OPEC to discuss oil production cuts. Regardless, the lack of further movement on the supposed oil cut between Russia and OPEC haven’t seemed to affect the oil markets as we’d expected. The lack of actual cuts being announced should have sent oil plummeting straight back down on that news alone, but instead it did virtually nothing for a few days before slowly sinking again.
Some analysts have speculated that Russia might have simply been testing the waters with OPEC to see what the reaction would be. Goldman Sachs speculated that a coordinated cut between them wouldn’t really do any good anyways. If oil values rose as a result of the cut, it would bring U.S. shale oil back into play thereby replenishing oil reserves and creating an even greater surplus.
Taking a Long View on the Oil Landscape
The temporary boost to oil prices on the rumor of a deal has since retreated back down to the $30 per barrel range. The brief boost in value revealed an undercurrent of false hope to which oil traders still seem to be clinging: catching a rally in oil prices. Unfortunately, we could be looking at low oil for an extended period of time.
The battle in the oil markets is largely blamed on the war between OPEC and the rest of the world that produces oil – specifically U.S. shale oil. OPEC fears losing its market share, and with that in mind has not cut back production even though there is a record surplus choking out any possibility of higher prices. OPEC has the ability to withstand low oil for a much longer period of time than other oil companies and the idea is to hold out until those companies go bankrupt and are unable to challenge OPEC’s grip on the industry.
Interestingly though, even OPEC can’t hold out forever with oil at $30 per barrel. The Iraqi Minister of Oil, Adil Abdul-Mahdi, stated that oil at such low prices means that even oil producers in OPEC are operating at a loss and cannot sustain that level indefinitely. In other words, oil will head back up, but whether it will be because of global macroeconomic fundamentals or OPEC finally relenting and cutting production is anybody’s guess.
The Bottom Line
As we head further into the year, we should see oil slowly begin to recover. The current $30 per barrel is unsustainable for any oil producer for very long and by the time summer hits, we should see prices appreciate to at least the $40 range. Adding to the confusion is Iran, which has begun to saturate the market even further with its oil as its only goal is to stake a claim in the market. Getting past $40 per barrel will almost certainly require unexpected positive economic news or a significant cutback in oil production by OPEC.
