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Last week, analysts at Citigroup slashed their forecast for crude oil to $20 a barrel before prices begin to recover based on two points: the amount of crude oil in storage and the end of OPEC’s role as the so-called swing supplier.
West Texas Intermediate (WTI) crude oil for March delivery closed at $44 a barrel on January 29 and at $52.65 this past Friday, about where it traded before Citi’s forecast was published. Crude dipped to $49 last Wednesday before climbing back up on Thursday and Friday.
U.S. crude in storage remains at an 80-year high, and there have been reports that foreign producers have been leasing tankers to sail around in circles with cargoes of crude waiting for the price to rise.
In the U.S., shale drillers have been cutting back on rigs at a pace of more than 80 a week for the past several weeks. But the cuts to rigs are not being accompanied by cuts in production.
OPEC’s influence on oil markets has been diminishing since the mid-1980s, and the so-far imputed ability of U.S. shale producers to replace the cartel as the world’s swing producer may soon be tested. The important point here is that oil cartel - and in particular Saudi Arabia, Kuwait and the UAE - have declined to fill their traditional role of balancing the oil market by turning the spigot on and off. Until demand can sop up the extraordinary supply, prices should remain low but are unlikely to fall to $20 a barrel. There is a caveat, though: should producers be unable to find swaps dealers willing to hedge future production, prices could go much lower than they are today.
Market participants are more optimistic about futures prices than swaps dealers, but as long as shorts vastly outnumber longs among the swaps dealers, producers will have difficulty hedging future production. Rig counts will continue to fall and production eventually will fall with the rig counts. What is unlikely, though, is that another $30 a barrel will be lopped off the price of crude.