Unexpected oil deal sees crude oil prices jump

OPEC announced yesterday a plan to reinstate a production cap for the group between 32.5-33.0 MMBOPD. The group reported producing 33.2 MMBOPD in its August report, meaning that OPEC would cut, at most, about 0.7 MMBOPD under the new agreement.

Unlike the last time OPEC tried to broker a production agreement, it appears now that Iran will be exempt from freezing or cutting production as it looks to reestablish its place in the global oil market following the end of international sanctions.

A variety of different forecasts emerged following the news Wednesday, but all agree the news is bullish, at least in the near-term.

OPEC deal expected to set a price floor at or above $40 per barrel

Analysts weighed in on the agreement and what it would mean for crude oil prices moving forward, with a variety of different expectations. Stifel said today that OPEC appears to be “building an oil price floor at $40,” while UBS took a more optimistic view saying that the floor would likely be in the mid-$40 range.

While speaking on Bloomberg, Tom Petrie of Petrie Partners said there is potential for prices to go as high as $60 per barrel.

“Can we get into the 50s, and maybe even into the 60s? Perhaps. But I do think we will see a supply response. There will be an incentive for those who can bring on new production,” he said.

At that price, hedging would become attractive for companies again, but it would also spur new production, effectively capping any further gains.

IHS Markit Vice Chairman Daniel Yergin echoed that sentiment, saying that activity would likely start up again around $50 per barrel.

EnerCom Crude Oil Model

EnerCom Analytics’ WTI Crude Oil Model predicts that a 200,000 Boe/d decrease in OPEC production would push oil prices towards $48 while a 500,000 Boe/d production cut would push prices above $50. This assumes that non-OPEC production from the U.S., Russia, and other major producing countries does not increase in response to higher prices.

Besides lessening supply pressure on the glutted world market, decreasing OPEC supply has historically been associated with a weakening dollar, as shown in the chart below. A weaker dollar makes it cheaper for other currencies to purchase dollar-denominated oil, pushing demand and prices up.

OPEC production and the dollar are strongly related. Where are oil prices headed?

Opec supply vs. trade weighted dollar (red line)

Since 2010, the dollar has strengthened in periods of increasing OPEC supply while holding steady or declining in periods of decreasing supply.

Market share could swing back to shale

While increased output from North American producers would create more downward pressure on oil prices moving forward, OPEC’s willingness to go back to a production quota may leave more market share up to grab for shale producers, Stifel said in a note today.

“If OPEC maintains production near its target and prices exceed our 2H16/2017 estimates of $45/$50, U.S. supply could rebound more quickly than our current forecast (2H17),” Stifel said. “Therefore, an OPEC agreement could further strengthen near-term prices although a non-OPEC supply response, headed by U.S. shale production, will likely cap longer term prices.”

Will OPEC be able to hammer out the details before the end of the year?

While the news was certainly bullish coming out of Algiers, many market spectators remain skeptical of whether or not OPEC will be able to follow through on the deal. The group plans to set country-specific quotas by the time it holds its next official meeting in November.

OPEC has encountered problems in the past of countries ignoring their production limits, putting much of the burden on Saudi Arabia.

“While Saudi Arabia offered earlier this week to cut output from 10.6 MMBbld to 10.2 MMBbld, we already forecast a decrease in production from the summer seasonal peak to 10.4 MMBbld in 2017. This could potentially account for 0.4 MMBbld of the 0.2-0.7 MMBbld estimated production cut required to achieve this agreement,” UBS wrote in its report today.

“I think it’s still pretty dicey that we’ll get a deal that matters, but this is conditioning the market,” said Petrie. “That’s really what this is all about.”

“Everybody (in OPEC) looked and realized they could lose another $5 or $6 per barrel,” if they didn’t come to an agreement, said Yergin, spurring the group to announce it planned to stabilize production. “Now there is some coherence. They’ve put a platform under the price.”

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