OPEC 'Cut' Strategy Headed for Failure?

 

Certainly there is an increasing disconnect between the rhetoric of OPEC and other producers cutting output on the one hand and the reality of a well-supplied crude oil market and mixed signals on the level of global inventories on the other.

 

The Organization of the Petroleum Exporting Countries and other producers, including Russia, have been touting the high compliance with the agreement to reduce output by 1.8 million barrels per day (bpd) from January to June.

 

It now appears that OPEC and its allies are moving to prolong the deal for another six months, with consensus building for an extension, which is likely to be announced at a meeting scheduled for May 25.

 

If the success of the deal is to be judged purely by prices, then an argument could be made that it has at least led to crude finding a floor above $50 a barrel.

 

Global benchmark Brent crude spent the second half of last year mainly between $40 and $50 a barrel, before being lifted after the OPEC and allies agreement was announced at the end of November.

 

When the deal took effect from Jan. 1, Brent traded in a narrow range for two months, before falling sharply in early March, but the support level of $50 held, with only a brief foray to an intraday low of $49.71 on March 22.

 

But Brent is once again testing the bottom of the post-agreement range, dropping to as low as $51.42 a barrel on Monday, as scepticism mounts over the ultimate effectiveness of the OPEC measures.

 

Perhaps more important for determining the longer-term price outlook is to look at the amount of oil available and the levels of inventories.

 

For OPEC and its allies to achieve their aim of sustainable higher prices, both global supplies and inventories have to be reduced, the so-called market re-balancing.

 

RECORD CRUDE BEING SHIPPED

 

It's here that the main evidence of the failure of the OPEC agreement is to be found.

 

Global oil shipments by tanker are at a record high in April, according to vessel-tracking data compiled by Thomson Reuters Supply Chain and Commodity forecasts.

 

As of Tuesday, the data shows that an average 50.3 million barrels per day (bpd) of crude is being shipped in April, up from the previous record 46.1 million bpd in January.

 

The data excludes crude moved by pipelines, but it's extremely unlikely that pipeline supplies have been cut by more than seaborne cargoes have increased.

 

The data also show that Saudi Arabia, which undertook to make the largest output cut among those producers party to the November deal, is actually increasing tanker shipments in recent months, to levels well above those that prevailed late last year.

 

The kingdom is expected to ship 8.29 million bpd in April, up from 7.94 million bpd in March, 7.73 million bpd in February and 7.83 million bpd in January.

 

Chinese customs data released on Tuesday showed that the world's biggest crude importer received higher supplies from Saudi Arabia, Russia, Angola, Iran and Iraq in March than it did the previous month.

 

The Chinese numbers don't exactly fit in with the narrative of successful output cuts, rather they show the opposite.

 

The picture that emerges shows there is a big difference between reducing output and actually cutting supplies.

 

It's quite likely the case that OPEC and its allies have been in high compliance with their agreed output cuts, but this hasn't necessarily translated into significantly lower shipments of crude oil.

 

An additional problem is that producers outside the agreement, such as the United States and Brazil, have been increasing production and shipments.

 

The plentiful supply of oil can be seen in global inventories, with the International Energy Agency saying recently that inventories in industrialised countries were still 10 percent above their five-year average.

 

To be sure, barrels stored in less visible places, such as in developing nations and in floating storage, do appear to be drawing down, but there is a question mark over whether this is happening fast enough to provide a basis for higher oil prices in future months.

 

But for OPEC and its allies to achieve lasting success, they will actually have to reduce the amount of crude being shipped.

 

It doesn't matter how much you talk about reducing output or drawing down producer inventories, what ultimately matters for the price is the amount of crude that buyers can access.