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OPEC still the 'greatest show on earth' for oil traders

The OPEC circus is back in Vienna this week for its bi-annual performance. One of the highlights as usual will be the somewhat desperate press pack in their usual role of clowns poring over every syllable from the ringmasters led by the Saudi Energy Minister Khalid al-Falih.

But in the week that Barnum & Bailey closed its doors for the last time, questions are once again being asked as to how much power OPEC now exerts?

The Saudi Oil Minister Khaled al-Faleh attends the 15th International Energy Forum in Algiers on September 27, 2016, on the eve of an informal OPEC meeting the next day.
Billal Bensalem | NurPhoto | Getty Images
The Saudi Oil Minister Khaled al-Faleh attends the 15th International Energy Forum in Algiers on September 27, 2016, on the eve of an informal OPEC meeting the next day.

Let's address this straight away. Clearly OPEC does not control more than a third of global supply and the world is currently consuming 96.5 million barrels per day (bpd), of which OPEC produces circa 31.8 million bpd.

However, last year's historic production cut also included a contribution from the Russians , who produce just under 11 million bpd, and sundry other non-OPEC players. This gives the producers serious sway on production if compliance is good, and compliance has by and large been pretty good.

So the question is why hasn't the extraction of 1.8 million bpd off the market actually produced the goods for OPEC? Why aren't prices in the more desirable $60 to $65 per barrel level, rather than languishing around $48 to $55? And why aren't record levels of global inventories being scythed? Surely such aggressive cuts should have produced more results?

There are many obvious reasons for these and other key questions over the strategy. In answer to the conundrum of stubbornly high inventories, the fact is OPEC has once again underestimated the response of shale in the U.S. to ramp up production on the back of the merest sniff of higher prices given that U.S. production costs continue to tumble.

In addition, while global demand is generally moving in a northerly direction (currently global demand is seen at 99 million bpd by the fourth quarter of this year as opposed to 95.7 million bpd in late 2015) it is still not as robust as had been hoped for, mainly on the back of slowdowns in previous stalwarts such as Germany, Turkey and India, according to the International Energy Agency (IEA).

Incidentally, one area of support for the suppliers has come from voracious buyer China, which has seen "relatively strong" demand growth according to the IEA.

And the price? Why hasn't it recovered to a level the producers would feel a lot more comfortable at, especially given their huge domestic budgetary needs? Maybe this is the wrong question though and perhaps we need to look at the dreaded counterfactual argument, for example, as JPMorgan points out: "An alternative to reaching an agreement in September and ratifying it in November (last year) would likely have been a return to oil prices in a $35-40 range". So maybe $55 is as good as it gets for now?

JPMorgan adds that in fact OPEC's strategy has supported prices and radically altered the dynamic for now, but goes on to note that unwanted consequences of the deal include actually reducing the risks around price and thus encouraged resurgent (U.S.) shale capital expenditure.
The fact is OPEC and its non-OPEC allies are still the real deal but have severe limitations in terms of what they can actually control.

OPEC cannot control demand, it cannot control shale rivals and certainly cannot control speculators. That said, the group will have to offer a big extension to the current deal timeline in order to support prices at current levels even if that leaves a bad taste in their mouths.

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