Crude oil prices rose slightly in light pre-Christmas trading ahead of the Jan. 1 implementation of OPEC’s promised output cuts.
The deal — finalized among OPEC member countries and a few non-member producer friends on Nov. 30 — calls for OPEC members to cut their production by 1.2 million bpd. A few participating non-members, notably Russia, are to cut their output by 600,000 bpd. Those cuts will come from a world pumping out close to 96.7 million bpd, meaning a nearly 2% drop in supply if the cuts are made. As small as that production cut appears, it will accelerate the rebalancing of the world’s oil market supply and demand, and should lead to sustained higher oil prices. At least that’s the objective, following two years of OPEC flailing as it tried to teach various parties a lesson for engaging in what the organization considered to be uneconomic behavior.
With Libya’s and Nigeria’s oil exports resuming and the sharp run-ups in output from Iran, Iraq and Saudi Arabia in the waning months of 2016, it's estimated that the agreed-to production cuts will only offset maybe 50%-60% of the 2016 OPEC output increases. If that holds true, then the world oil market can only look for around 1 million to 1.2 million bpd of output actually being eliminated from global supplies in 2017. This explains why crude oil futures prices have only rallied to slightly above $50 bbl for WTI, and longer term prices are only about $3 bbl higher.
Producers have taken advantage of higher future oil prices to lock in profits, meaning they will have little incentive to stop producing if current oil prices drop. This is why many industry observers believe producers will have to be happy — and seek profitability — with oil prices hanging in the $50-$55-bbl range. Will that be enough to stimulate increased offshore drilling and completion work? Doubtful. The industry probably needs to see prices rise closer to $60 bbl before getting excited about drilling again. However, if the lower price range appears sustainable, the industry needs to search its exploration prospect inventory to find those projects that will work in that lower price range.
The next several months will prove challenging for the industry, as every bobble in oil prices will make producers jump. Will those price changes tell us anything about the long-term future for oil prices, or will they merely be short-term reactions to transitory industry news and events? There will be little clarity about the direction and level of oil prices for a while, so take every forecast with a grain of salt. Better yet, ignore all the expert opinions tossed around during January. Instead, watch for indications that demand is either strengthening or weakening. Then look to see what the major OPEC exporters are doing — and don’t pay attention to what they are saying. Lastly, pay attention to how rapidly U.S. oil shale output grows. Together, these three forces will shape the oil market of 2017, and set the stage for 2018-2020.