November 8, 2016    4 minute read

Oil Everywhere: Can OPEC Close The Floodgates?

Are Higher Prices On The Horizon?    November 8, 2016    4 minute read

Oil Everywhere: Can OPEC Close The Floodgates?

It has been two years since OPEC decided to start flooding the market with excess supplies of oil in an attempt to squeeze out higher-cost rivals, such as Brazil’s deep waters and the US shale drillers.

This has had a significant effect on the oil industry, evident in the drastic decrease in oil prices over the past two years. According to OPEC’s World Oil Outlook paper (2016), “the OPEC Reference Basket (ORB) price dropped by nearly $90 per barrel, or 80%, between June 2014 and January 2016, from $111 per barrel to below $23 per barrel.”

The Domino Effect

This significant drop in prices has had a negative effect on investment in Exploration and Production (E&P) within the industry as a whole, with OPEC stating that they anticipate the total cut in investment will approach $300bn over the two years. The cuts have meant massive job layoffs in the industry, many projects being cancelled, and huge negative economic consequences for oil exporting countries.

Alexander Novak, The Russian Energy Minister, further quantified the severity of the current climate within the oil industry at the International Energy Forum (IEF) in Algeria, stating that the current oil market crisis has proven to be the most impactful in the last 45 years.

During the IEF on September 28th, OPEC members decided that enough was enough and came to an agreement to cap oil production for the first time in eight years as a means to increase global oil prices. According to the energy ministers, OPEC agreed to reduce output to between 32.5m-33m barrels a day.

This news was welcomed by markets as crude oil prices – the global oil benchmark – increased by a little over 6%. There was a further 3.5% increase in crude oil prices after Vladimir Putin made it clear at the World Energy Congress in Istanbul that Russia (the world’s largest oil producer in 2016) was willing to co-operate with production cuts.

How The Oil Price Can Rise

If OPEC manages to implement these output restrictions successfully, then the price of oil will rise, and although the market is not looking at prices reaching previous highs of $100 per barrel, some analysts have estimated it could rise to above $60 per barrel next year.

This would lead to an increase in exploration and production investment once again and will mean higher profits for energy companies which is also good news for the bulls holding long positions in energy stocks.

On the other hand, the rise in oil prices will not be welcomed so warmly by consumers as the price of all goods and services involving oil in their production will increase unless the higher oil costs are offset by a reduction in the cost of some other factor input or by an increase in productivity. In addition, countries that are huge importers of oil will face higher import costs thus negatively impacting their current account.

$60 is some analysts’ estimate for
an oil barrel next year

However, it must be stated that whether OPEC will actually manage to implement these production cuts or not is uncertain as they face a number of hurdles. Nigeria and Libya are actually expected to be increasing oil output due to the fact that domestic conflicts have heavily disrupted their output in recent years.

Furthermore, Iran is expected to have an exemption from the production cuts as it is recently coming off of heavy sanctions that have affected its oil output and Iraq, the second largest producer in the cartel, is claiming that it cannot cut production as it needs oil revenues to fight IS.

Consequently, the burden of these output cuts will lie more heavily on the other OPEC members and on the non-OPEC oil producing countries.

What Is The Long-Term Price?

OPEC will officially meet in Vienna on November 30th. However, the market’s lack of faith in the cartel’s ability to implement these production cuts has been evident in the fact that crude oil prices have dropped since hitting the high of $53.73 per barrel in mid-October, now pricing at below $50 per barrel.

This scepticism is shared by Jeff Currie, the Global Head of Commodities Research at Goldman Sachs, thinks these low prices will be around for a while and has estimated that the long-term price of oil will stay at $50 a barrel.

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