Yesterday, the International Energy Agency (IEA) released its Oil Market Report for December. In the report, the IEA noted that it believes that OPEC produced roughly 34.2 million bbl/d in November, or an additional 500,000 bbl/d from OPEC's recent estimate for the month. These numbers call into question the authenticity of OPEC's reporting and render a 1.2 million bbl/d cut from the cartel significantly less impactful. Undoubtedly, the biggest question mark surrounding OPEC's recent historic production cut is the cartels ability to not cheat on the numbers (which historically has been a problem). If the market senses that OPEC members are not adhering to their newly defined production quotas, prices will turn negative quickly. The next three to six months will provide the market answers as to whether the cartel is strong enough to hold to its newly stated production quotas. The IEA also noted in its December report that it has revised its estimate for Chinese and Russian consumption prompting the agency to raise its forecast for global oil market demand growth this year by 120,000 bbl/d to growth of 1.4 million bbl/d. A strengthening demand picture globally combined with OPEC's recent production cut (should the cartel adhere to the new quotas) will undoubtedly send oil prices significantly higher in the coming months (potentially into the $60-$65 bbl/d range).
To the surprise of many market watchers, OPEC members on Wednesday put aside their differences and cut production for the first time in eight years. Specifically, the cartel will cut 1.2 million barrels per day and have set a new annual production target of 32.5 million barrels per day. Notably, Saudi Arabia will absorb the lion’s share of the production cut at roughly 0.49 million barrels per day. Other notable details of the deal is non-OPEC nations (mainly Russia) have also agreed to cut 0.6 million barrels per day. If OPEC is successful in implementing these cuts on January 1, 2017, it would signal a return to its traditional role as price fixer and foregoing the pump-at-will policy introduced in 2014. On the demand side, strong GDP growth around the globe (particularly in the U.S. where Q3/16 GDP numbers hit 3.2%), should support oil prices longer term. Also, U.S. President-elect Donald Trump's plan to spend billions on infrastructure, should further spur demand for oil.
Overall, with an OPEC production cut deal now in place, the new norm for crude prices will likely be between $50 and $60 going forward. Longer term, the one wild card that may ultimately place a ceiling on oil prices at $60 per barrel is the substantial amount of production in the U.S. that is ready to come onto the market. Notably, the U.S. shale industry is very nimble and has significantly reduced its costs to produce a barrel of oil in recent years. Should oil surpass $60 per barrel, this would likely trigger a reactivation of a significant amount of production in North Dakota. Undoubtedly, market watchers will be closely monitoring the U.S. drilling rig count in the coming months. Should the rig count start to tick up meaningfully, investors will again become conscious of the oil supply situation globally. Nevertheless, OPEC cutting production is a big win for energy producing countries around the world, as the alternative could have led to oil plunging to $25 per barrel. Energy company's and investors are collectively breathing a sigh of relief, after having struggled with low oil prices for nearly two years.
A Canadian Energy expert