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One topic of some discussion is when will we feel the effects of OPEC (and non-OPEC) production cuts? Obviously, oil markets have already reacted to the cuts, driving up the price of Brent and WTI substantially since the announcement of the deal. However, key questions remain: will OPEC and non-OPEC members who agreed to cuts comply, when will we know if they complied, and when will markets reach balance?
The issue of compliance and when we will know whether OPEC and non-OPEC members have complied is a bit tricky. The United States is by far the most transparent country when it comes to production and storage numbers. As we have discussed numerous times, OPEC does not even trust itself – which is why it publishes the production numbers each country gives officially, and then numbers from secondary sources. These secondary sources, and how they are calculated, are fascinating and range from shipment receipts to at least one company that specializes in tracking tankers to help determine true production and export numbers.
OPEC publishes its Monthly Oil Market Report. But even its figures are one month delayed. OPEC released its December report on December 14, 2016, which gave production numbers for November 2016. Therefore, in our best case scenario, we will not know until mid-February how much OPEC production actually fell.
And that is the larger question. Saudi Arabia has stated that it will implement most of its cuts immediately, and its Gulf allies are expected to follow suit. In fact, some sources have reported that Saudi Arabia has already fully implemented their agreed production cuts. Certain countries are exempted from output cuts but ongoing issues make their ability to produce further questionable anyway. Russia and others have not really given a time frame, but are expected to gradually implement cuts.
It therefore makes sense that markets will begin to tighten more in the second half of 2017. By then, non-OPEC members who adhere to their deal will have gradually phased out production. The U.S. summer driving season will be in full swing, and refiners will have increased demand.
Incidentally, hedge fund activity seems to agree. You may recall our discussion of a contango market vs backwardation in the last edition of Ty’s Take (click here to read more: http://www.fsmetals.com/about-us/newsletters/tys-take-for-the-week-ending-12-16-16). Current trading activity indicates that market rebalancing is backloaded to the second half of the year, with future prices trading in contango in the first half of 2017, but then moving to level or backwardation in the second half – suggesting that traders view the market as not reaching balance until the second half. However, it does appear that traders are acquiring more and more net long positions – which might just be confidence in an OPEC freeze but may also indicate that they believe the market will switch from contango to backwardation sooner. We will just have to monitor.
At the end of the day, all of the data suggests that markets will reach balance in the second half the year. Logic seems to dictate such a result. Of course, if OPEC and non-OPEC members are more aggressive than anticipated, markets may reach balance sooner.
By: Ty Chapman
Five Star Metals, Inc.
Raising the Bar for Customer Service and Quality
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