February 17, 2016 / 3:18 PM / 4 years ago

Oil market shows deep doubt over output freeze

LONDON (Reuters) - The oil world has been shaken this week by some of the biggest producers agreeing to freeze their output at January levels to contain a supply glut and prevent a further slide in prices, but markets show investors doubt this tactic will work.

A worker walks past a pump jack on an oil field owned by Bashneft company near the village of Nikolo-Berezovka, northwest from Ufa, Bashkortostan, Russia, in this January 28, 2015 file photo. REUTERS/Sergei Karpukhin/Files

The oil ministers of top exporter Saudi Arabia, Qatar and Venezuela, together with non-OPEC member Russia, said after meeting in the Qatari capital of Doha on Tuesday they had agreed to keep output unchanged from January, provided other big guns followed suit.

Iraq and Kuwait said they would observe a freeze, on the proviso that enough other large exporters did the same.

The wild card is now Iran, returning to the markets after years of sanctions on its exports, which said it will resist any such curbs and stick to its pledge to increase production by 1 million barrels per day over the coming six to 12 months.

Oil ministers from Iran, Venezuela, Iraq and Qatar met in Tehran on Wednesday but the result of the meeting was not yet known.

Tellingly, the longer end of the Brent futures price curve suggests that, for now, investors doubt that any such freeze would tilt the market into a supply deficit any time soon.

The proposal is aimed at stemming a 20-month decline in the oil price that has slashed the value of a barrel by more than 70 percent, after U.S. shale oil output and near-record production from OPEC and other major producers such as Russia created one of the largest global surpluses in modern times.

Benchmark Brent futures prices were little changed from Tuesday’s close, up just 87 cents a barrel at $33.05 a barrel by 1211 GMT.

“Doha may have ended in an agreement but it opens up more questions than it answers. All the meeting has done is highlight the difficulties in reaching any agreement. The market needs a cut, not a production freeze,” David Hufton, an analyst at broker PVM Oil Associates, said.

In January, OPEC and Russia, the world’s largest producer, were already pumping at or near record highs.

The premium for oil in a year’s time compared with oil for immediate delivery briefly spiked to nearly $9 a barrel on Tuesday, after the announcement, only to be winched back to a four-month low around $6.

The larger the gap between the two prices, the greater the expectation among investors for the supply of oil to be less plentiful in the future and the gap right now is at its narrowest since October 2015.

Looking further out, investors do not expect the oil price to trade far above $40 a barrel even by December next year.

The December 2017 Brent futures contract trades at a premium of just over $10 to the front month April contract.

Even if the major producers did agree to freeze or cut production, nimble U.S. shale producers could take advantage by boosting output to replace any fall in supply.

Some analysts believe the major producers, who can produce barrels at low cost, may be better off putting up with a period of low prices to drive higher-cost competitors out of business.

“A sizeable, visible and lasting cut would clearly send a bullish signal to markets – in the short-term. But given U.S. shale players’ ability to bounce back, and U.S. investors’ desire to pounce amid a dearth of other opportunities, this could quickly re-stimulate production, and prices could arguably stay lower in the medium-term in this case,” analysts JBC said in a note.

“In other words, absorbing more pain now, for those who can, might be better than changing strategy at a time when players only live from the hope that rescue is around the corner.”

Reporting by Amanda Cooper; Editing by Adrian Croft

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