The oil market increasingly resembles a tug of war between two well-balanced teams. The question is what happens when one side finally gives way.
Since the start of the year, crude has traded in a narrow range of just $5 a barrel, supported on one side by Opec joining with Russia to agree production cuts, but pressed on the other by a resurgent US shale industry, reawakened by prices back above $50 a barrel.
The tensions in the market are acute. Hedge funds have lined up behind Opec by placing record bets that crude is finally ready to march higher following a two and a half year decline.
The early signs suggest that the speculators’ instincts in backing Opec to make good on their pledged cuts were correct, with export tracking indicating more than 75 per cent of the agreed reduction appears to have already been enacted, a level of compliance higher than the historical norm.
But that has not yet been enough to break prices out of their 2017 malaise.
“Saudi Arabia is leading the charge here, sending a signal to the market that it has implemented full compliance via lower exports,” said Matthew Smith at Clipper Data, a company that monitors oil imports and exports. “Other countries, for the most part, have fallen in line.”
The problem for oil bulls, traders and analysts say, is the physical market is still languishing under near-record stockpiles and ample supplies.
Short-term demand has been hit by refinery maintenance in some regions, while hopes that Opec’s cuts will tighten the market later this year risk being overshadowed by the bigger structural shift still looming over the market in the form of a nimble shale industry.
“The first half of 2017 was always going to be difficult,” said David Wech at JBC Energy in Vienna.
“Opec can tighten the market, but we’ve always doubted they would be permanently able to shift the market balance. The US shale industry has been a game changer because it can respond to price signals in less than a year.”
1. Jan 20 2016 — Brent crude price hits 12-year low
2. April 17 2016 — Doha talks end in failure
3. Nov 30 2016 — Opec reaches agreement on how to distribute output cuts
4. Dec 10 2016 — Non-Opec producers such as Russia agree to join oil deal
5. Jan 2017 — Opec oil production cuts due to take effect
US shale drillers have squeezed down costs and can now operate with lower prices. They have also become more efficient, getting more oil from each well drilled.
The tension between Opec and shale is playing out not just in the relative stasis of spot prices but also on the forward curve, where traders can take a view on how the market will shake out in the coming years and producers can hedge future production.
Currently, the curve, though far from a perfect indicator, suggests traders think that Brent crude will inch higher in the next few months, from $55.50 for April delivery to $56.50 for the September contract. From there, however, prices are either flat or slightly lower all the way out to 2021.
However, oil prices are not predicted to remain so placid for long. Many analysts expect the current period of low volatility to be an anomaly. At some point in the oil market tug of war one side will give way, at least until the other can regain its footing.
Citi analyst Edward Morse said this week that oil markets over the next five years were likely to be characterised by shale capping rallies about $65 a barrel but with “wild swings” in between.
The impact of politics, shale’s largely untested ability to respond to supply disruptions, and Opec’s ability to try once again to weaken rivals by opening the taps should all contribute to more volatile trading.
“Wild cards abound to both the bullish and bearish side,” Mr Morse said. “Oil prices could see $20-$30 per barrel swings within short timeframes.”
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