As warned here one month ago after the farcical OPEC meeting in Algiers, the cartel's latest jawboning ploy to keep prices artificially higher - if only for one more month - is fast falling apart. Just a few hours ago, Bloomberg reporter Daniel Kruger penned the following assessment of the situation:
Production-Cut Talk Is as Good as It Gets for Oil. Some OPEC members are talking about cutting production again, and so prices are rising. Saudi Arabia and other producers both in and out of the cartel have done a good job fostering the storyline that there are terms under which parties can agree to pump less crude. Continuing signs of concord among producer nations have boosted oil prices to an average of $50 a barrel this month in New York. Yet several obstacles make it difficult for countries to commit to signing on to a deal. One obstacle is that sacrifices are needed for the agreements to succeed. Another is that those sacrifices aren’t shared equally.
Having successfully raised $18 billion in the bond market, Saudi Arabia is better positioned to withstand the loss of some revenue. Iraq, OPEC’s second-biggest producer, was the latest to plead for an exemption from a cut, citing its fight against Islamic State as a cause of hardship. Ultimately, no one wants to pump less because the upside is so limited. Saudi Arabia’s 2014 decision to double down on production in a drive for market share succeeded in making it more difficult for higher-cost producers to thrive as they once had. But having committed to that goal, they also locked themselves into a fight to keep what they’d won.
And while ConocoPhillips’ announcement this week that it plans to cut spending on major projects demonstrates the partial success of the Saudi plan to drive out rivals, it also shows producers see diminishing chances for crude to climb much above $60, said Wells Fargo Fund Management’s James Kochan. The big reason, of course, is latent U.S. supply. Baker Hughes data shows the most rigs at work in the Permian Basin since January. Sanford C. Bernstein analyst Bob Brackett suggests the per-acre price of drilling lease land will rise to $100,000 from about $60,000 now.
The one agreement players seem to have reached is that oil isn’t able to go much higher.
That oil's upside is capped at this point is clear; in fact as both Goldman and Citi have warned, unless OPEC can come to a definitive and auditable agreement - no just another verbal can kicking - in which the member states, by which we mean almost entirely Saudi Arabia as most of the marginal producers are exempt or want to be, immediately curtail production, oil will promptly crash to $40 or below.
But an even more amusing twist is that a plunge in oil prices may be just what US shale producers are waiting for. The reason for that is that while OPEC has been busy desperately jawboning oil higher, US producers have been worried about oil's reacquaintance with gravity. As a result, as the EIA reports, the amount of WTI short positions held be producers and merchants is just shy of a decade high.
According to a recent EIA report, short positions in West Texas Intermediate (WTI) crude oil futures contracts held by producers or merchants totaled more than 540,000 contracts as of October 11, 2016, the most since 2007, according to data from the U.S. Commodity Futures Trading Commission (CFTC). Banks have tightened lending standards for some energy companies as crude oil prices declined throughout 2014 and 2015, and some banks require producers to hedge against future price risk as a condition for lending.
Short positions of WTI futures increased at a faster pace than futures contracts of Brent (an international crude oil benchmark) since summer 2016, suggesting U.S. producers are able to drill for oil profitably in the $50 per barrel range. In the Crude Oil Markets Review section of the October Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration (EIA) discusses an increase in U.S. onshore producers’ capital expenditures that is contributing to rising drilling activity, which EIA projects will lead to an increase in U.S. onshore production by the second quarter of 2017.
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Which closes the circle of irony: almost exactly two years ago, Saudi Arabia set off a sequence of events with which it hoped to crush US shale producers and its high cost OPEC competitors. It succeeded partially and briefly, however now the remaining US shale companies are more efficient, restructured, have less debt, a far lower all-in cost of production; and - best of all - they will all make a killing the next time oil plunges, as it will once OPEC's hollow gambit is exposed.
Meanwhile, the last shred of OPEC credibility will be crushed, the truly high cost oil exporters within OPEC will suffer sovereign defaults and social unrest, as will Saudi Arabia. The good news for Riyadh is that at least it got a $17.5 billion in fresh cash from a bunch of idiots who will never get repaid. We are curious just how long that cash will last the country which burned through $98 billion just last year, before the threat of social unrest and financial system collapse returns? Two months? Three?