When OPEC met last on November 30, 2016, the cartel reached a tentative agreement to reduce crude oil production by 1.2 million barrels a day. The optimism generated by the hope of that agreement drove the price of oil from the mid $40s to above $50 a barrel. That 18% bump has generated a fair amount of optimism among U.S. oil producers, however, those that are counting on stable $50 + WTI should consider all the headwinds that could push it backward.
The OPEC Agreement Is Tenuous At Best
OPEC members are not known for playing by their agreements. There is a good chance that the agreement could fall apart during the next OPEC meeting December 10, 2016. For the agreement to hold, many analysts estimate that both OPEC and non-OPEC producers like Russia must all participate and bring down production by 1.7 million barrels to make a significant difference.
There Are A Number Of Spoilers In The Market
Currently, Russia (a non-OPEC producing nation) is producing at near full capacity. Russia is producing approximately 11.2 million barrels per day (a 30-year high) and Russia has signaled that it may not cooperate with OPEC. If Russia doesn’t play, then OPEC countries like Iran, Venezuela, and even Saudi Arabia may not honor the agreement. Even if all OPEC and non-OPEC oil producers agree to their assigned reductions, there is a long history of cheating which wouldn’t really help in decreasing production.
Production needs to be reduced by about 1.7 million barrels a day, and OPEC’s agreement is only requiring a 1.2 million barrel per day reduction.
OPEC is Increasingly Becoming Irrelevant To The World Oil Economy
Back in 1973 when OPEC began asserting its power in the oil economy, the price of a barrel of oil rose from $3.00 to $12 globally. The U.S. economy reeled as a result. There was a repeat of OPEC’s dramatic influence in the early 1980s.
Middle-Eastern oil was the largest source of oil for the world and when they turned off the spigot, they demonstrated to the world they could control the price of oil. Fast forward to today, shale oil, technology, and industrious oil and gas people have dramatically raised the production output in non-OPEC countries like the U.S. Since the gas lines of 1973, the U.S. has risen dramatically in oil production. Now the third largest producer behind Russia and Saudi Arabia, the U.S. is producing about 9.5 million barrels of oil per day. Other non-OPEC countries that are large producers include China, Canada, Brazil, Mexico, Norway, the United Kingdom, and Columbia.
Technology like horizontal drilling and fracking has allowed countries like the U.S. to dramatically increase their daily production. For every barrel of oil produced in a non-OPEC country, OPECs influence decreases a little.
OPEC’s Meeting On December 10, 2016
OPEC’s next meeting will be December 10th. If they can’t get Russia (the largest non-OPEC oil producer) on board with production cuts, there is a good chance the current agreement will fall apart. If that happens, some experts predict the price of oil could drop into the 30s and even the high 20s. If that happens, there is really no reason for the price to rise until existing inventory drops. Should there be no artificial production decreases among OPEC countries, the only event that will decrease the current inventory and drive the price of oil back up will be increased demand caused by economic growth. The only two countries in the world that could make a large difference in demand are China and India. A tiny bump in their GDP would cause a significant increase in demand for oil, thus allowing the price to rise.
Other Issues That Could Affect the Price Of Oil In The Short-term
Historically, December is the lowest demand month of the year in the U.S. Demand for oil is low in December happens because refineries often do maintenance in the last two weeks of December and the first several weeks of January. Additionally, refineries often want to reduce their finished inventories by December 31st to decrease tax they must pay on finished inventory. Finally, even though American travelers travel for December holidays, they travel less in December than they do in Summer months.
How Low Can The Price Of Oil Drop This Year?
Last January the price of oil dropped into the $20s. That low price remained started in December and didn’t start rising until February 2016. It is not unreasonable to see a similar drop this season, though the bottom might be in the low 30s rather than the mid-twenties.
If you are in the business of buying existing production, we could see the next six months being a buyer’s market. Should this prediction become reality, the price should slowly rise to the mid $40s by late Spring.
The principals of Business Finance Solutions have been helping oil and gas E&P companies and service companies raise equity and secure debt since 1994. Contact us by online form or call at 512.990.8756 if you would discuss your company’s capital needs.