Lower US Supply to Underpin Oil Price Despite Talks Failure

April 2016, Vol. 243, No. 4

LONDON (AP) — The failure by oil-rich nations to agree to freeze production sent crude prices lower Monday.

But prices recovered much of their losses by afternoon, and analysts said that oil is likely to rise in the longer term as many companies, particularly in the U.S., scale back output.

The effort to reach a consensus on limiting production to support prices failed after Iran stayed away from a weekend meeting of 18 oil-producing nations in Doha, Qatar. Saudi Arabia said it wouldn’t back a deal if regional rival Iran, which is trying to ramp up output as international sanctions are lifted, wasn’t involved.

The price of oil fell as much as 7 percent after the talks ended but then bounced back. The contract traded in New York closed down 58 cents, or 1.4, percent, at $39.78 a barrel Monday, while the international standard, Brent, fell 19 cents to $42.91.

Oil fell in the past two years from above $100 a barrel to touch 12-year lows under $30 a barrel earlier this year. Prices, however, have rebounded by more than 50 percent since mid-February, partly on the expectation that major producing countries would freeze production.

The inability of OPEC countries and Russia to freeze production levels means they will likely continue to pump oil at near-record rates. However, other producers — notably U.S. shale companies, which face higher costs — are cutting back on production to cope with the lower prices. Some have even gone bust. That has the potential to support prices.

Last week, before the Doha meeting, the U.S. Energy Department and the Paris-based International Energy Agency both reported that U.S. production was declining.

The IEA noted signs that “the much-anticipated slide in production” of shale oil in the United States “is gathering pace.” The IEA, a group of oil-consuming countries including the United States, added that by early April the drilling-rig count in the U.S. had fallen nearly 80 percent from the peak seen in October 2014 and that there was more anecdotal evidence of financial problems taking a toll on shale producers.

Lower potential U.S. supply is one of the reasons why oil prices have rallied in the past two months — alongside expectations of some sort of deal emerging at the meeting in Doha.

Fadel Gheit, a senior energy analyst at Oppenheimer & Co., said the recent cutbacks in investments will help rebalance supply and demand in the longer-run whatever the short-term disruption caused by the Doha failure.

“We believe prices will rise regardless of what OPEC does or does not do, as U.S. shale oil production, not Saudi Arabia, will be the new swing producer,” Gheit said. “We believe oil prices will rise to a sustainable level closer to $60, the new normal, not $100 and not $40 either.”

The failure of the talks in Doha prompted a knee-jerk response in the markets that was tempered perhaps by news of a strike by oil workers in Kuwait to protest government cutbacks.

The market volatility appears driven in part by speculative investors, “oil tourists” who drive the price up and down on expectations about things like the Doha meeting, said Kit Juckes, a strategist at bank Societe Generale.

In the longer-run, he said, oil prices will be supported “as slowly increasing demand catches up with slowly decreasing supply and stock-building comes to an end.”

One likely impact of the Doha talks’ failure is that traders may scale back expectations that a deal will emerge in the future, starting off with the next scheduled OPEC meeting in June. Rather than coordinated production cuts by the cartel, the market may see unilateral actions from individual countries.

The cheap oil price has a huge impact on the economies of crude-producing countries, particularly the poorer ones like Angola, Nigeria and Venezuela.

“Unless Saudi Arabia or Iran has a change of heart, we fail to see how the outcome (at the June meeting) will be any different, and it may ultimately be mounting supply disruptions in stressed states, rather than collective cartel action, that causes an accelerated market rebalancing,” said Helima Croft, global head of commodity strategy at RBC Capital Markets.

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