OPEC can’t save oil market alone—the U.S. has to step in, says Morgan Stanley
OPEC and other major oil producers have taken on an ambitious battle to rebalance the oversupplied oil market, but despite the best intentions their efforts aren’t enough, Morgan Stanley warns.
In a Thursday research report, the Wall Street bank called on U.S. shale-oil producers to join in efforts to tackle the global supply glut that has pummeled prices since the summer of 2014.
“If OPEC doesn’t balance the market, the oil price will have to force it somewhere else, most likely in U.S. shale. For a chance of a balanced market in 2018, the U.S. rig count can no longer grow and possibly needs to contract ~150 rigs. Given current break-evens, this requires WTI between $46-50,” the Morgan Stanley analysts said in the report.
Cementing their downbeat assessment of the oil market, they significantly downgraded their 2017 forecasts for both West Texas Intermediate and Brent. They now see WTI trading at $48 a barrel at the end of the year, down from $55 expected previously. For Brent, they cut their forecast to $50.5 from $57.5.
Oil prices have been volatile in recent months, even as the Organization of the Petroleum Exporting Countries and other major producers—including Russia—have eased output. They initially agreed to a six-month pact running from January until the end of June, but as prices remained stubbornly low, they extended the accord into the first quarter of 2018.
The OPEC and non-OPEC members have signed up to cut output by a collective 1.8 million barrels a day, hoping it will bring global oil inventories to a five-year average. The Saudi Arabian and Russian oil ministers have even pledged to do “whatever it takes” to balance the market.
However, there may be a limit to “whatever it takes,” according to the Morgan Stanley analysts.
“Although compliance has been healthy, OPEC’s production cuts have so far made little dent in inventory levels, which are still roughly as high as a year ago,” they said.
“To support prices in the mid-$50s, OPEC-12 would probably need to lower production by another 200,000-300,000 barrels a day and extend the output agreement to end-2018. We find this unlikely,” they added.
Out of the 14 OPEC members, only 12 are included in the output restrictions. Libya and Nigeria are exempt because production in those countries has been hit by internal conflicts. Supply from both nations, however, has risen recently, seen as partly scuttling OPEC’s efforts to bring down inventories.
Additionally, U.S. shale producers responded to the higher prices that came after the OPEC deal by ramping up production rapidly, helping to offset the global production cuts.
There have been green shoots in the market, however. According to the International Energy Agency’s monthly report, demand outstripped supply in the second quarter, and that shortfall should be “significant” in the second half of 2017.
But unless someone does something, that trend could quickly turn again, Morgan Stanley warned.
“The combination of little impact on physical balances, but a strong signal to invest has meant that the OPEC cuts have had a perverse effect: on current trends, the oil market would be oversupplied again in 2018,” the analysts said.
That is why U.S. producers need to stop some pumps too, they said. Ideally the number of rigs need to fall by 120-180, according to Morgan Stanley, to constrain output to a level that doesn’t flood the oil market.
The weekly Baker Hughes rig count last Friday showed a decline in active oil rigs for the first time in 24 weeks. The number of rigs fell by two to 756.
“If the U.S. rig count were to stabilise, it would impact production relatively quickly. However, perhaps still not as fast as is generally perceived. Even U.S. shale does not respond instantly,” the analysts said.
Not everyone is as downbeat on the oil market, though. UBS commodity analyst Giovanni Staunovo said earlier this week that both Brent and WTI could rally more than 20% before the end of 2017. That is partly because he believes demand will continue to outstrip supply, and partly because he sees a chance U.S. production will disappoint.
“If the market outside the U.S. is already in a deficit, the U.S. is not immune to that. It’s a global market, so it will also affect the U.S,” he said.
“You’ve had reports indicating [the U.S.] can even produce at $20 a barrel. But let’s see if last week’s rig count is a start of a trend or not—if it’s the start of a trend it shows that they also have some issues producing at these price levels.”