JPMorgan: As Market Yawns At OPEC Production Cuts, Watch Price Of Oil Drop Further

As the price of oil dropped significantly Thursday, moving from a high near $52 into the $48 region, JPMorgan says the downdraft is likely to be reflective of OPEC production cuts priced into the market. While WTI is higher in mid-afternoon trading, the price might ultimately find a gravitational pull lower, the report noted.

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How much impact do OPEC production cuts actually have on the price of oil?

When OPEC production cuts were announced, extending the agreement to keep oil off the market by nine months, it was only greeted by markets with a yawn. In fact, selling ultimately occurred.

As David Martin, JPMorgan’s global commodities research analyst, looks at the announcement and the market reaction, he concludes in a May 25 report that the consensus had already priced in such a move. Buy the rumor, sell the fact.

OPEC production cuts used to have more significant meaning than they do today. In fact, OPEC had a much better grasp on market pricing before those pesky Americans started to figure out how to find oil by finding it in shale and drilling sideways using new technologies.

When the US shale oil production boom hit, the price of production was high along with the triple digit price of oil. But technical advancements keep lowering the cost to extract a barrel of shale oil. In fact, many of the Middle Eastern nations, with their costly government social programs embedded in the price of oil, might soon find themselves at a meaningful production cost disadvantage, particularly if technology continues to work its magic in the US shale patch.

In wake of OPEC production cuts, price of oil expected to drop in short term

In his May Oil Market Monthly report, Martin touched on the rabbit hole of how lowered US oil production costs and its supply is muting the impact of OPEC to control prices. With a supply/demand picture in clear view, he made a short term forecast for the price of WTI Crude, which might see significantly lower prices by of 20% or more.

“Prices are likely to see further short-term weakness in the coming days as producers use the opportunity to hedge 2018 production,” he wrote. “Similarly, some speculative length will likely exit and fresh speculative short positions will likely enter the market, now that uncertainty about deeper/longer production cuts has been removed.”

Martin lowered his WTI price forecast by $11, moving it to $42 per barrel, while his Brent forecast sees a drop of $10 per barrel and a $45 price target.

In the near term, Martin holds to his belief “oil markets will tighten in the coming two quarters,” but such a move will not be enough to lift oil back above his previous target of $60 per barrel.

Noting the long range consequences of OPEC’s production desires, this “will likely prove unpleasant for the cartel’s members,” many of whom have a history of producing more oil than they agreed, a factor Martin anticipates. “We assume that the OPEC/non-OPEC deal collapses at the end of 4q’17, as cheating becomes untenable for core OPEC members,” he wrote, noting that oil prices could become depressed in 2018.

Considering the monthly report’s upward revisions to supply estimates, Martin now sees the delicate balance between supply and demand in 2018 “having to accommodate a substantial build in inventories,” with such oversupply lowering prices.

The question is how will this impact the US shale producers. If the price of oil drops below their production costs, will they continue to produce? Martin thinks not. “Effectively, we assume that low oil prices will once again need to curb investment by non-OPEC producers – with the emphasis on shale producers.”

Looking at OPEC’s agreement to protract the “production restraint,” what has Martin concerned is the lack of a coherent plan. “What concerns this analyst is the lack of an effective exit strategy,” he wrote.