Crude oil prices dropped below $50 per barrel after the Organization of Petroleum Exporting Countries (OPEC) took the path of least resistance in the bid to end the supply glut in oil. Crude oil prices have been depressed for much of the last three years because the supply of oil in the market is simply more than the demand. The supply glut is a function of the return of some oil producers such as Libya and Iran to the market. In addition, U.S. shale oil producers are adding new rigs and pumping out more oil.
Last year OPEC announced a momentous deal between its member nations and some non-OPEC producers to reduce their oil output. The supply cut deal championed by Saudi Arabia targeted a reduction of 1.2 million barrels per day. However, the supply cut only had a marginal effect on reducing the supply and oil prices remained practically depressed. Market Watchers were hoping that OPEC would take more decisive action in its just-concluded meeting in Vienna.
The crude oil market is disappointed in OPEC
Crude oil prices crashed almost 5% on Thursday, May 25 after OPEC released a press release on its Vienna meeting. Brent Crude was down 4.7% to $51.44 per barrel and the West Texas Intermediate was down 4.8% to $48.90. The declines in the global crude oil market also trickled down to the energy sector of the U.S. stock market as the S&P 500 energy sector lost 1.8% in the trading session.
The main reason for the decline in the market is that investors were disappointed in OPEC and its lack of a coherent plan to salvage the crude oil market. OPEC announced that its member nations have agreed to extend the current production cut for another nine months. In essence, OPEC will continue to reduce output by 1.2 million barrels per day until March 2018.
Erick Chambers, an analyst at Saxon Trade notes that “the market is not impressed by OPEC’s decision to extend the cuts because the previous cuts haven’t had any meaningful effect on ending the supply imbalance.” Market watchers were actually hoping that OPEC would deepen the cuts or agree on an outright production freeze in order to force a balance on the demand-supply dynamics of oil.
Investors are also not happy with the fact that OPEC is still exempting Nigeria and Libya from the production cuts. In addition, OPEC is allowing Iran to continue to increase its production levels up to 3.797 million barrels per day.
Here’s what OPEC can do to save oil
OPEC’s actions to extend the production cut is a mockery of the whole exercise – an exercise in futility at that. The deal to reduce oil production sounds halfhearted since it moves one-step forward and two steps backwards. Crude oil storage data are still at multiyear highs globally because many traders stored oil when it was selling cheap in the hopes of reselling at a profit when the price of oil increases.
OPEC also inadvertently contributed to the deluge of oil in storage. Many OPEC member-nations ramped up production last year ahead of the production cuts so that they would have oil to sell when the production cut gets underway. OPEC must find ways to drain the deluge of oil in storage if it is serious about forcing an increase in global oil prices.