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Crude oil price pressure to resume after brief tightness gives way to oversupply

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Crude oil price pressure to resume after brief tightness gives way to oversupply

OPEC production cuts aside, Jefferies analysts expect the crude oil market to become oversupplied and see downside pressure for prices into 2020.

Russia, Saudi Arabia and the United States comprise about 40% of total liquids production globally, making the three countries the dominant players in the global oil market, the International Energy Agency said in its recent monthly oil market report.

"Cooperation between Russia and Saudi Arabia is now the basis of production management with these two countries having a large capacity to swing output one way or the other," the IEA said.

At a Dec. 7 meeting, OPEC members agreed to cut 800,000 barrels per day from October levels beginning in January, and non-OPEC members said they would cut an additional 400,000 barrels per day.

Considering the market was oversupplied by an estimated 1 million barrels per day in November, Jefferies analyst Jason Gammel said Dec. 13 that he expects a slightly tighter first half of 2019 due to the 1.2 MMbbl/d of production cuts. Gammel expects the market to be undersupplied by 800,000 barrels per day in the first half of 2019 if OPEC adheres to its production targets.

The combination of OPEC-plus cuts, curtailments in Canadian production and further sanctions-related declines in Iranian exports should be sufficient to drive Organization for Economic Cooperation and Development inventories back below the trailing five-year average and could result in a tight market in early 2019, Gammel said.

Crude oil futures rallied in Dec. 13 trade on the New York Mercantile Exchange, closing the session with a $1.43/bbl gain at $52.58/bbl.

"Maybe, just maybe, with near record demand in the U.S. and China, and OPEC's 800,000 barrel a day production cut, along with 400,000 barrels from Russia, 325,000 barrels from Canada and a force majeure on exports from the 315,000-barrels-per-day oilfield in Libya, perhaps they are starting to figure out that the market globally will soon be undersupplied," PRICE Futures Group analyst Phil Flynn said Dec. 14.

But crude oil futures turned to the downside Dec. 14, closing the session down $1.38/bbl at $51.20/bbl, and extended the retreat in the fresh workweek, closing the Dec. 17 session below $50.00/bbl to a 14-month low of $49.98/bbl.

From an oil consumption standpoint, the U.S. welcomes lower prices, but additional price reductions put Russia and Saudi Arabia's budgets under great stress, the IEA said. Further, with the U.S. now the world's biggest crude oil producer, and where production is managed at corporate levels, decisions to produce or not to produce will be economically driven, according to the agency.

"Producers will want to see [crude oil prices] stay high enough to encourage further investment," the IEA said.

While the IEA said time will tell how effective the new production agreement will be in rebalancing the oil market, Gammel said that as incremental pipeline capacity is installed in the Permian Basin in the second half of 2019, U.S. production growth will almost inevitably reaccelerate, and the market could move back into oversupply by early 2020.

As U.S. production grows, net imports that have fallen from an average of 11.1 MMbbl/d in 2008 to an average of 3.1 MMbbl/d in 2018 will continue to decline. U.S. oil will compete in many markets, including some now dominated by OPEC members.

Gammel said the call on OPEC will fall to 31 MMbbl/d by the first quarter of 2020, versus October 2018 OPEC production of 32.3 MMbbl/d. In other words, by 2020, the Saudis would need to reduce their production to 9.2 MMbbl/d day to keep the market in balance.

Prompted by the expectations, Jefferies cut its 2019 Brent price forecast to $65.75/bbl from $75.00/bbl and trimmed its 2020 price to $62.75/bbl from $70.00/bbl.