With oil prices dropping below $45, losing all the gains from the Organisation of the Petroleum Countries (Opec) output cut, crude markets are in for some real, fundamental, trouble. Since May 25, when the Opec opted to roll over a 1.8 million barrel per day output cut for another nine months, crude prices have fallen about 12 per cent.

Inventories are reportedly near record highs in many parts of the world. The US oil output is on increase. The Libyan and Nigerian output is on up and is seen by many as undermining the efforts led by Saudi Arabia. Adherence to the stated cut is under scrutiny as Opec output rose by 336,000 bpd in May to 32.14m bpd.

In the meantime, the “Opec 2017 year-to-date exports are only down by 0.3 million barrels per day (bpd) from the October 2016 baseline,” analysts at AB Bernstein wrote.

In the meantime, non-Opec production from Canada to Brazil is also contributing to the mess, with traders expecting the prices to fall further.

“The market is in trouble,” Tamas Varga, an analyst at London brokerage PVM Oil Associates told Reuters.

The US output is jumping, going up by 10pc over the past year to 9.33m bpd. Continued rig additions in the US are complicating the picture, raising doubts on Opec’s strategy,” AB Bernstein said.

The US government’s Energy Information Administration has raised its forecast for domestic output growth in 2017 to 460,000 bpd from a predicted decline of 80,000 bpd in December. Opec now expects US production to increase by 800,000bpd in 2017. As per the EIA, the US onshore production from the Lower 48 states will grow by 340,000 bpd in 2017 and another 500,000 bpd in 2018.

Shale firms have hired an additional 425 rigs to drill for oil since end May 2016, more than doubling the active rig count, Baker Hughes reported.

US shale producers together with other non-Opec producers are now expected to capture all of the increase in global oil demand in 2018 and raise their share of the market significantly – at the expense of Opec.

The International Energy Agency says it expects non-Opec oil supplies to outpace demand next year despite consumption hitting 100m bpd for the first time.

“Our first outlook for 2018 makes sobering reading for those producers looking to restrain supply,” the IEA said in its monthly oil market report.

A rapid rise in US shale oil output will contribute to the increase in non-Opec supply next year, the IEA concedes now. Shale producers and Opec are on a collision course. The battle for market share in not too distant a future could not be ruled out.

What could the Saudis do in the circumstances?

Saudi Arabia, which has a large refinery on the US Gulf Coast, was reported to be planning to hold back some exports, to the US in July. That could show up immediately in the EIA’s import data and inventories as a bullish signal.

“I think their next plan of attack is to drop exports to the US so they can manufacture a drop in the EIA report,” said John Kilduff of Again Capital told CNBC. “It will make it look like inventories are really coming down.”

Of the 8m barrels a day imported into the US last week, Saudi Arabia probably supplied about 1m barrels a day, said Kilduff, adding that it could come down by 100,000 to 250,000 barrels a day.

“The Saudis understand the importance of changing optics in the US and are following it up by continuing to signal that they are going to reduce shipments into the US,” said Helima Croft, global head of commodities strategy at RBC. She said Saudi Arabia’s energy minister has made clear that reducing US shipments was an option.

“It’s a good time to reduce because they’re going into seasonal domestic demand swings,” said Croft. Saudi Arabia uses more oil domestically during the summer months for its utilities.

Another silver lining for the crude producers is the issue of sustenance. Who can sustain and longer? Lower oil prices are set to test the US shale drillers too, John Kemp counter asked in his piece.

Some US shale producers claim they can produce oil profitably with prices well below $50 per barrel or even $45 per barrel; the oil market is likely to put those claims to the test.

An interesting battle between the Opec and shale producers is on and the crude markets continue to be faced with real headwinds.

Published in Dawn, June 18th, 2017