Crude Heading for Biggest Drop in 20 Years as Traders Reject OPEC Cutback Effectiveness

Despite U.S. oil inventories falling by a larger than expected 2.7 million barrels last week according to the Energy Information Administration, traders reasserted their bearish sentiment on Tuesday by causing West Texas Intermediate to drop 2.25 percent to $42.53 and Brent to fall $1.20 to $44.82 per barrel.

Even Saudi Arabia's decision to replace Muhammad bin Nayef with Mohammad bin Salman as crown prince didn't sway the market, which is presumably a disappointment to the kingdom: as CNBC reported, Amrita Sen, chief oil analyst at Energy Aspects, pointed out the Saudis need higher prices to bolster the value of their initial public offering of their national oil and gas company, Aramco.

So far this year, oil has slid 20 percent, the weakest performance since 1997: good news for buyers, but bad news for Organization of the Petroleum Exporting Countries (OPEC) members who need higher prices to boost their ailing economies, and presumably bad news for U.S. shale producers, whose ability to generate profit diminishes the closer crude reaches the $40 mark.

The reason for the continued market losses is familiar: "The market wants proof that OPEC cuts are shifting petroleum balances, and it's not getting it; crude prices are now on the hunt to find the stress point for the U.S. producers, and we're not there yet," said Anthony Headrick, energy market analyst at CHS Hedging LLC.

John Kemp, market analyst for Reuters, noted that with U.S. producers poised to seize more than half of the projected growth in global liquids consumption of 1.54 million barrels per day (bpd) in 2017 and 1.62 million bpd in 2018, OPEC and its allies "will eventually respond by increasing their own output to protect market share against the threat from U.S. shale producers."

He added, "Prices are likely to overshoot on the downside, as traders drive them lower than necessary owing to the lags in the system, which will create conditions for a subsequent rally"; however, he conceded that the rally will be a limited one.

As further declines in crude prices seems inevitable, Liam Denning, columnist for Bloomberg Gadfly, suggested that the market is being overly unresponsive: he noted that with regard to bin Salmon assuming the role of the Saudi crown prince, "A decade ago, even a rumor of change at the top of the OPEC kingpin would have been enough to jolt prices higher."

Denning added that "It is easy to lay out a bullish scenario for oil prices based on what's happening in the Middle East," but that one of bin Salmon's goals is to get his kingdom to a point where it can live with sub-$50 oil: "The more progress the millennial-in-chief makes on that, without burning down the house, the harder it will be to inject some drama into prices."

But at least one expert believes the market is behaving precisely as it should: Warren Gilman, chairman and CEO of CEF Holdings, recently theorized that the low to mid $40s is the right place for crude to be, and he argued that given increased production from global players and relatively weak demand, "why in the world would we have an environment of rising oil prices?"