Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Hey, OPEC, you did it, guys! Look:

Yay! Oh...
News of an apparent OPEC freeze agreement led U.S. E&P stocks to end Wednesday 6 percent higher
Source: Bloomberg
Note: Intraday times are displayed in ET.

Wait, you didn't want to boost U.S. exploration and production stocks? Huh. Well, you did it anyway. Even better, you did it without technically having really done anything.

OPEC delegates have ostensibly agreed to cut their crude-oil production to around 32.5 to 33 million barrels a day. The range is the first clue there is much work yet to be done in order to turn those numbers into reality. The second clue is that production allocations for individual members haven't been set yet. Instead, how the pain gets shared will dominate OPEC's next formal meeting in November.

How much of a dent would that cut make in the global oil glut? It would be big but not decisive on its own.

Here's the math: The Energy Information Administration projects there will be 3.09 billion barrels of commercial oil inventories sitting in tanks in OECD countries by the end of the year (the bulk of global crude storage capacity is in the OECD, so I'm using it as a proxy). It forecasts that number to keep rising until next summer but then start dropping, ending 2017 at 3.06 billion -- helpful but still a huge burden.

Take OPEC production down to 32.5 million barrels a day through 2017, though, and, all else equal, it implies inventories starting to drop early next year, falling to about 2.9 billion barrels by year's end. At 30 days of projected global oil consumption, that would get us back to where we were in the first quarter of 2015. Not the stuff of oil-price spikes, but definitely supporting higher prices than the $52 a barrel or so where December 2017 Brent crude contracts trade now, and likely heading higher.

Cutting The Glut
All else equal, an OPEC cut would drain commercial oil stocks back to early 2015 levels, relative to demand
Source: Energy Information Administration, Bloomberg Gadfly analysis
Note: Implied OECD oil inventories based on EIA projections. OPEC cut scenario assumes OPEC output of 32.5 million barrels a day through 2017.

The size of the proposed cut, which is material but not immediately needle-moving on the inventory glut, also suggests this agreement in principle is designed to nudge Russia into also cutting output. A coordinated cut of that sort, echoing the rescue party cobbled together at the end of the 1990s, could start draining reserves much more quickly -- if it was actually implemented and maintained. 

Except, of course, neither OPEC or Russia exist in a vacuum.

Raising prices would dampen demand growth -- in a year already looking dicey for the global economy -- and, of course, throw a lifeline to U.S. producers.

As I wrote here, despite the oil crash, shale output has proven more resilient than expected, due in large part to very accommodating capital markets. The jump in the E&P sector that greeted Wednesday's news suggests the door will remain open. You can bet every E&P company with access to a phone will soon be dialing their investment bankers (or maybe it's the other way around).

Right now, those EIA projections have U.S. oil output continuing to drop through most of 2017. Revived hopes of an OPEC floor could attract the capital needed to change that.

Saudi Arabia, which has championed the strategy of maximizing market share over the past 2 years, is well aware of this risk. So why has it seemingly thrown in the towel?

One obvious answer is that the country needs a breather. This week, the Kingdom took the painful -- and politically risky -- step of slashing salaries and bonuses for state employees. And just as news of the supply cut was leaking out in Algiers, U.S. lawmakers were voting to override President Obama's veto on legislation that would allow Saudi Arabia to be sued for involvement in the Sept. 11 attacks -- a move that could delay a giant sovereign bond sale planned by Saudi Arabia.

If Saudi Arabia's retreat is a triumph of short-term relief over longer-term aims, then it represents a strategic setback for the Kingdom and raises questions about its commitment to other radical initiatives, such as the IPO of Saudi Aramco. Equally, Wednesday's move could be a political stunt designed to head off the immediate fallout from this week's salary cuts, with the understanding that it all comes apart at November's OPEC meeting anyway.

Whatever the truth, OPEC has shown one thing: It still has the power to move markets with no more than a vague proposal. But it is left with two big problems.

First, having now, on its second attempt, apparently agreed to reverse course and intervene in the oil market, it will have to deliver if it is to retain any credibility or cohesion. This is far from certain at this point.

Second, along with oil, OPEC's rhetoric also boosts two other markets: namely, for the stocks and bonds of U.S. oil producers. And talking those up works directly against the rebalancing of oil supply and demand that OPEC's apparent pivot supposedly seeks.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net