Oil and Gas

Oil surges on output cut extension but analysts caution upside is capped

Not enough focus on oil demand, rather than supply: UBS

Oil prices surged on Monday morning following a joint commitment on Sunday from Saudi Arabia's and Russia's energy ministers to extend the existing oil production cut agreement until March 2018.

By 1:20 p.m. London time, the U.S. domestic benchmark West Texas Intermediate (WTI) was trading 3.6 percent higher at $49.55 while the international Brent price had gained around 3.3 percent to trade at $52.53.

However, analysts cautioned that relentless pressure from U.S. shale oil producers mean that any resurgence is likely to be tightly contained and short-lived.

Oil is going to range trade between $40 and $55 per barrel while the marginal cost of production in the U.S. remains in the middle of that spectrum at around $50 per barrel, according to James Butterfill, Head of Research and Investment Strategy at ETF Securities.

"Every time oil tests that level…you see clients trading around it," Butterfill observed, speaking on CNBC's Squawk Box on Monday.

"Every time it goes below that $50 a barrel level, it's a buying opportunity and roughly when it hits about $50, we see a lot of selling at that point," he added.

The past week has seen a pick-up in flows with Butterfill noting that clients had bought around $130 million of crude oil in the past week with his firm, as part of year-to-date inflows to the asset class for his firm of around $340 million.

Analyst consensus now sees a cap on prices at around $60 according to Dean Turner, economist at UBS Wealth Management, also speaking on CNBC's Squawk Box on Monday.

"What we're seeing in current oil prices is probably sustainable in terms of where projections for the earnings stream are going," Turner estimated.

Oil well pump jacks located in Almond Orchard located over the Monterey Shale in San Joaquin Valley.
Citizens of the Planet | Getty Images

Yet Butterfill emphasized his skepticism over the commodity's ability to maintain such a high level even in spite of the positive developments out of OPEC over the weekend.

"Every time Saudi Arabia or OPEC try to manipulate oil prices they're being undermined by the United States," he said, referring to the quick ability of shale producers to up output as soon as the economics made sense once again.

Given current dynamics, this looks to be unlikely a game which Saudi Arabia or other higher cost producers are positioned to win in the short-term, given that the marginal cost of certain fracking basins – such as the Permian basin – has dropped to as low as $36 per barrel.

This compares to a total fiscal cost – including state obligations such as social welfare – of around $70 or $65 in Saudi Arabia and Iran, respectively, according to Butterfill.

The Saudi Arabians' enthusiasm to extend the agreement must also be viewed in the context of upcoming capital market events.

"It's also worth noting that the Saudi Arabians are in the process of listing Aramco [Saudi Arabia's national oil and gas company], and therefore will require a stable oil price to support their $2 trillion valuation of the company," Sam Wahab, director of oil and gas at Cantor Fitzgerald Europe, told CNBC via email on Monda.

Returning to the theme of the threat from U.S. shale, Wahab agreed that the key downside risk continues to stem from growing U.S. production.

"A further nine U.S. oil rigs were added last week, bringing the total count up to 712 - the most since April 2015. It is very likely this trend will continue at current oil prices," Wahab contended.

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