Crude Prices Are Rising and OPEC Isn't Happy

Crude Prices Are Rising and OPEC Isn't Happy

How can that be?

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WTI crude futures climbed to its highest price level in more than three years after the American Petroleum Institute (API)  reported an inventory draw of 11.2 million barrels last week. That’s nearly triple the estimate in a Bloomberg survey and if the Energy Information Administration (EIA) data on Wednesday shows a similar pull from inventory, it would be the largest draw outside of the summer driving season, since 1999. As of the time of this writing, the February WTI contract is now solidly above $63. Demand continues to grow steadily, so much so that in their monthly report released on January 6th, the EIA raised their average price estimates for both 2018 and 2019. OPEC cut production hoping to reduce the supply of crude oil in inventory closer to its 5-year average and as a direct effect, lift prices. In terms of inventories, it's clearly working. Different reporting agencies have different totals but the trends are all the same, the excess crude oil above the 5-year average has been reduced by nearly half. So OPEC is happy, right?

Not so fast. Prices have moved much higher, much quicker than OPEC hoped. Many analysts have spoken of U.S. production and the theory that if prices rose above $50, the shale producers in the U.S. would "turn the wells back on" and there would be a flood of production sending prices rapidly lower. This idea of turning wells on quickly has always been wrong and OPEC knew this. Many questioned the strategy of production cuts and higher prices but OPEC knew that the U.S. shale industry had layoff about 75% of its workforce when prices fell from the $100's to the $20's and $30's. Many of those workers were transplants from other parts of the country and they may not be likely to come back only to get laid off again when prices fall. Many companies also slowed down (and in some cases completely stopped) capital spending and new exploration. The key was to get the inventory overhang down and let prices rise slowly but surely and hopefully, have the inventory glut almost completely reversed by the time demand picks up in the summer.

The U.S. production is growing and the EIA estimates the U.S. will cross 10 million barrels per day in 2018 but it has been rising slowly and some even think the EIA is overstating U.S. production figures. Given that prices have moved much higher and much quicker than OPEC hoped, that slow walk may turn into a quick jog for U.S. production. With the curve firmly in contango and prices high enough in the front month to pull the back months up with it, the shale drillers can make great money now and hedge out lower prices further out o the crude curve at fairly favorable rates. This could lead to hiring and capital spending on equipment and exploration. This is not good news for OPEC if sustained. It is good news for shale drillers. 

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