Is the oil war over?

Word came from Algeria last week: The oil war is over. OPEC’s leading producers agreed to a planned reduction in output starting in November that will help tip the balance of supply and demand into a deficit and begin eating into the historically high global oil inventories. Crude futures jumped on the news. Traders are claiming that the industry’s good days will soon return.

Of course, all this assumes that there was, in fact, a war between OPEC exporters and U.S. frackers. Many in the industry and the media have made this argument since OPEC threw up its hands in November 2014 and turned oil prices over to market forces.

In the almost four-an-a-half years before that OPEC decision, U.S. oil producers had boosted domestic output by four million barrels a day, to levels not seen in 28 years. The industry was booming. Unfortunately, all that additional supply merely added to the global oil glut, pushing down oil prices and eventually sending the industry into its worst recession in decades.

Now, OPEC members have cried “uncle!” The financial pain from low oil prices has become too great. They need more cash to keep their countries running – and possibly keep the governments in power. Now the question is how high oil prices will go, and how quickly will the industry go back to work?

Oil companies are in the early stages of budget planning for 2017, meaning they will be working to decipher where oil prices are headed and how quickly. They will set their spending plans based on what they estimate price trends will be in 2017. The good news is that they can safely look forward to larger cash flows next year. The bad news is that they will have little confidence in that outlook until at least six months have passed and oil prices remain elevated or are steadily rising.

While several oil industry capital spending surveys suggest small increases next year – targeting around 5% – that money is unlikely to start flowing before the second half of 2017. If oil prices begin trading above $50 bbl., there will be lots of positive talk about how things in the industry are getting better. The problem is that the words will not be backed by dollars for a while.

Oil company executives, familiar with OPEC’s history of cheating on agreements combined with a lack of specifics about this deal, won’t act until they see “the whites of their eyes.” It’s still impossible to know precisely when that will be, but the outlook is the most promising it’s been in quite a while.

About the author

G. Allen Brooks

G. Allen Brooks is a 40-year veteran of the energy and investment industries, serving as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a board member of several oilfield service companies. He is the author of the highly regarded energy newsletter “Musings From the Oil Patch” that interprets trends within all sectors of the energy business.

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