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November cover


A look at OPEC's decision concerning crude production
Cost Management Solutions    
Cost Management Solutions
The holiday we just celebrated may have been Thanksgiving, but it would have been very easy to mistake it for the Fourth of July. In the energy sector, there were plenty of fireworks on Thanksgiving Day.

The Organization of the Petroleum Exporting Countries (OPEC) had its long-anticipated meeting to discuss its production target for 2015. Throughout 2014, OPEC had a production target of 30 million barrels per day (bpd). The cartel often produced above target, helping add to a glut of oil that has had crude prices falling since June.

West Texas Intermediate (WTI) crude traded to a high of $107.73 on June 20 and hit a low of $63.72 on Monday. The global benchmark Brent crude traded at a year-high of $115.71 on June 19 and fell to $67.53 on Monday. Those are losses of 40.85 percent and 41.64 percent, respectively.

For the most part, market participants have miscalculated when predicting recent moves by OPEC. Such highly respected commodities traders as Goldman Sachs expected OPEC to step in with production cuts as soon as Brent crude fell below $100. OPEC has often said $100 crude is fair for both producers and consumers.

Further supporting analysts’ views of OPEC being aggressive in defending crude prices was the knowledge that many OPEC countries need high crude prices to meet government budgets that are highly dependent on crude revenues. Below is a table showing the estimated crude price the International Monetary Fund (IMF) and the Arab Petroleum Investments Corp. (APICORP) believe is needed for OPEC countries to meet government budgets.

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With nine of the 12 OPEC countries needing Brent crude above $98 to avoid budget deficits, the theory that OPEC would begin defending prices at that level had a lot of merit.

However, historically it has been OPEC’s largest producer - Saudi Arabia - that has borne the brunt of any production cuts. More often than not, some OPEC countries have actually increased production whereas Saudi Arabia was cutting production to support prices.

Leading up to the Nov. 27 meeting of OPEC, many members of the cartel said there would be a production cut. Libya said at the least OPEC would cut its production so it was equal to its current target of 30 million bpd. Libya also believed it was very possible a cut in the production quota would be made to 29.5 million bpd. But through all the rhetoric and positioning of other OPEC nations desperate to see the drop in crude prices stopped, Saudi Arabia consistently said it would let market forces determine crude supplies.

The current glut has been caused by weak global economic conditions and a rapid increase in U.S. crude production from about 5 million bpd in early 2006 to more than 9 million bpd now. The rapid increase was caused by a breakthrough in technology that allowed crude to be produced from shale formations.

Similar conditions occurred during the late 1970s, the last time the world was awash in crude. In 1980, OPEC - primarily Saudi Arabia - began cutting production to try and support prices. Saudi Arabia continued to cut production for more than five years, only to see its global market share plummet as non-OPEC and even other OPEC countries gained market share at Saudi Arabia’s expense. Saudi Arabia production fell from 10 million bpd in 1981 to around 3.5 million bpd by 1985. The Saudis ran up huge amounts of debt during this span.

By 1985, Saudi Arabia had seen enough and began producing crude at its full capacity, causing crude prices to further decline to less than $7 per barrel. By doing so, many conservation efforts, alternative fuel initiatives and high-cost crude production projects were shelved. Slowly, crude supplies decreased and crude prices began recovering.

Saudi Arabia learned its lessons well. Conditions in 2014 are similar to what they were in 1980. It knows that cutting production to try and support prices will only encourage more high-cost crude production projects, mostly in the U.S., resulting in lower market share for them. It also knows that many of its fellow OPEC members are not in good shape financially and will likely strive to take market share from Saudi Arabia, as they did between 1980 and 1985.

Saudi Arabia has the lowest crude production costs in the world. It plans on using that advantage to make sure it maintains its market share in this falling price environment. It knows it is far better off keeping market share, even at lower prices, than it is giving up market share to both non-OPEC and OPEC producers.

Saudi Arabia believes that lower prices will cause high-production-cost projects in the U.S., the primary cause of the current glut, to be shelved. It appears it is correct. An exclusive report by Reuters showed that 15 percent fewer oil drilling permits were sought during October for the 12 largest U.S. shale crude fields than were applied for in September.

Most believe there are enough projects on the books to keep U.S. production growing through the middle of 2015. But most producers/drillers have already announced cuts in their capital spending programs for 2015 and beyond. There is a lot of variance on what price level U.S. producers need to make shale plays pay. Of course, it varies with each field and the first plan will be to focus expenditures on the lower-cost fields. Further, there has been a reduction in the cost of producing crude from shale formations, as more knowledge and economies of scale are gained.

Frankly, it is anyone’s guess as to when there will be enough reduction in production to begin to tighten up supplies, thus pushing crude prices higher. Based on the limited information available, it would appear the midterm (next six months) prospects for crude remain bearish without a surprising turn in the global economy or some unforeseen geopolitical event.

If crude prices remain soft in the midterm, that will take away yet another potential support for propane prices. Even with propane prices low, one has to be very careful adding a lot more supply for the winter of 2014-15. However, the prospect that current prices could yield excellent buys for 2015-16 is fairly good.


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Propane prices were flat on the holiday-shortened week despite a solid draw in inventory of nearly 2 million barrels reported on Wednesday. Weak crude prices were a weight on propane.

Crude prices fell as it became clearer OPEC would not cut production at its Nov. 27 meeting.

As expected, OPEC did not cut production and propane prices fell sharply on Monday to catch up with a 12 percent drop in crude prices that followed the OPEC decision. With the correction in the books, we are neutral short term on the expectation the pullback could draw in buyers for both crude and propane.

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Last Week's Highlights
Propane prices moved higher as crude moved lower. Crude traders were being cautious ahead of OPEC’s meeting on Thursday. Recent cold weather appeared to be the key support for propane.
Crude prices slipped, as a meeting between Saudi Arabia, Russia, Mexico and Venezuela ahead of OPEC’s official meeting on Thursday gave no indication that a production cut would be made. Propane prices flattened out as traders looked toward Wednesday’s Energy Information Administration (EIA) report.
The EIA reported a nearly 2-million-barrel draw on U.S. propane inventory, but the report had little impact on propane prices, with both hubs closing flat to Tuesday’s close. Crude prices fell again on consistent information from OPEC that it would not cut production.
Markets closed for Thanksgiving holiday.
Markets closed for Thanksgiving holiday.

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