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We may still have to wait some time for the bull market

The week before the Eid holidays, oil officially entered the bear-market territory, with the price falling more than 20 percent from its peak in January.

Indeed, for the first time, oil went below the watermark prior to the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC oil producers’ deal to cut production. The commodity has recovered slightly since then with Brent Futures closing at $48.77 on Friday.

Late last year, OPEC and 11 non-OPEC countries agreed to curb production by 1.8 million barrels per day (bpd), which led to a quick price spike with Brent reaching $60 a barrel in January. After that Brent traded in a comfortable range of between $50 and $55. When the deal was extended by a further nine months, markets failed to react with enthusiasm. Indeed the commodity seemed to go into a tailspin.

Crude oil inventories were slow to react. They are still 26 percent above the five-year average, which is a metric that oil markets like to watch. Even when crude inventories in the US fell by 2.5 million barrels during the week of June 18, markets did not react.

As soon as oil prices started to rise in January, US shale production, which is more expensive compared to conventional production, came back with a vengeance. Indeed the rig count in the US stands at 941, which is more than double where it was a year ago. US shale production is expected to reach 5.5 million bpd in July. The reduction of 100,000 barrels in late June was due to temporary factors, such as tropical storm Cindy. Canada is also expected to increase its production by 590,000 bpd over the period of 2017 and 2018.

We can expect this now more resilient and cost-effective shale sector to keep on giving. The question is by how much, and for how long?

OPEC’s compliance with the production-cut deal has been stunning, at a level of around 108 percent. Markets probably overreacted to the production increases by Libya and Nigeria, which at around 340,000 bpd were substantial in terms of those countries’ production rates, but negligible in terms of global production. Libya and Nigeria were exempted from the deal due to their internal political situations.

The Saudi energy minister has pointed out time and time again that we need to give OPEC’s measures time to work their way into the system. He is right: Oil inventories will come down, but they will do so gradually and over time.

Cornelia Meyer

Earlier this week, Goldman Sachs adjusted its three-month average projections for West Texas Intermediate (WTI) to $47.5 bpd, down from $55 bpd. Other analysts followed suit. Goldman called the outlook “cyclically bullish within a structurally bearish framework.” This is due to the increased shale production in the US and an unexpected surge in Libya and Nigeria’s oil production.

What are we missing is that markets tend to react quickly and based on relatively arbitrary benchmarks. Saudi Energy Minister Khalid Al-Falih has pointed out time and time again that we need to give OPEC’s measures time to work their way into the system. He is right: Inventories will come down, but they will do so gradually and over time. 

We also need to allow for seasonal adjustments like refinery maintenance schedules and other factors. So Goldman Sachs is correct in saying we are in a cyclically bullish framework. The International Energy Agency (IEA) forecasts that global oil consumption will grow by 1.3 million bpd this year and 1.4 million bpd in 2018. 

The economies in Europe, the US and China are doing well, which always bodes well for oil demand. US shale production has been the dark horse because it came back faster than expected. Shale producers have also managed to become leaner and a lot more efficient. Still, US shale constitutes around 5 percent of the global production and we cannot satisfy demand without conventional oil at this time.

There is one caveat, however. Many OPEC and non-OPEC countries have signed up to the deal expecting that the production cuts will result in higher oil prices. This uplift in revenue was expected to more than compensate for the missing production. Let us hope that compliance with the cuts deal can be sustained, should the price-versus-volume assumption be put to a test for a sustained period of time.

• Cornelia Meyer is a business consultant, macro-economist and energy expert. She can be reached on Twitter @MeyerResources.