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Looming Supply Comeback Could Hinder Oil Market Recovery

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Hao Luo's Blog
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Seeking Alpha Analyst Since 2014

Energy market research analyst focusing on macro and oil market


  • OPEC+ will ease the production cut and bring back supplies to the oil market.
  • Libya is reopening its oilfields.
  • US production decline is going to moderate as oil price recovers.
  • All the new supplies will hinder the oil price recovery.

The oil market has made a strong comeback in the past three months, with oil price nearly doubled from March’s level. Much of the oil price recovery was due to the unprecedented production cut from OPEC and its alliances (OPEC+). The 9.7 mmbd production cut, which is around 10% of world’s oil production, clearly boosted the market confidence and starting to make the dent on the oil inventory.

Now with most of the world’s major economy entities being re-opened, people expect oil demand to pick up and further support oil price. However, the recent re-spike of Covid-19 cases in U.S. are casting doubt on the swift oil demand recovery. Supply cut seems to be the main support for this recovery now. However, the story from the supply side is also facing uncertainty now.

The biggest unknown now is how OPEC+ will continue their production cut. OPEC+ is reported to achieve 107% cut compliance rate in June, but this could be the peak of the cut compliance. The rising oil price and continuing free riding from non-compliant members are starting to disintegrate the alliance. Saudi Arabia has been vocal in discontent over Angola and Nigeria and threatening a possible price war, as both countries haven’t met their production cut targets. Russian Energy Minister Novak is reported to expect OPEC+ easing oil production cut in August. A possible 2 mmbd cut ease is a big number to add to the market.

The rationale behind the move to ease the cut is understandable. Most OPEC+ countries had substantial oil revenue loss from both low price and volume cut. Gulf countries are running fiscal deficit with low oil revenues. Some of these countries, such as Russia, have also been hit hard by the Covid-19 and facing economy hardship. With oil market show signs of improving, most of these countries are eager to raise their oil revenues. It’s not if but when OPEC+ will reverse the course and add supply. What once the tailwind to the oil market rebalancing will soon become the headwind.

Another looming supply side risk comes from Libya. Libya’s production has fallen this year as oilfields and ports are blocked due to domestic unrest. The production loss was estimated to be around 900 kbd since January. Now with the negotiation between the different tribes, the oilfields are about to restart production. The country’s largest field, El Sharara, has gradually resumed production and aims to reach full capacity of 300 kbd in the next three months. More fields are under negotiation to restart. Libya’s production has fluctuated in the past years and the reopening of fields has constantly gone back and forth, making a full production reopening unlikely. However, even a partial reopening could add meaningful supply to the already bloated oil market.

What’s also concerning is the pace of U.S. production decline. After adjusted for the hurricane’s impact, the pace of U.S. oil production decline in the past three weeks has shown moderation, with the latest week being flat sequentially, compared to prior weeks’ declines of 100 kbd or so. Though weekly number could contain noises, evidence for the decline moderation can also be found elsewhere. More shale companies are reported to restart the production as the current $40 oil price makes economic sense to produce at certain wells. Primary Vision, a third-party industry consultancy and data company, has reported that the number of well fracking workers have increased by 56% in the past five weeks. This shows that cash-strapped shale oil companies are starting to bring back the fracking crews to complete some drilled but yet producing wells. Completing these wells has the lowest need for cash investment to produce, which are the quickest way to boost the oil output and cash income. These signs show that the biggest part of U.S. production reduction may have happened, and going forward, the decline may slow down or even plateau.

With the uncertainty in demand recovery, the reversal of production decline can tilt the market imbalance and hinder the oil price recovery. The oil market has staged a great comeback but the rally is likely to run of steam soon.

Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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