Oil Producers Pin Hopes on OPEC Meet Outcome

Oil production cut would help oil prices to rise to $55 to $60 a barrel

o1Investors in the world’s biggest energy producers are pinning their hopes on Organization of the Petroleum Exporting Countries (OPEC) to arrive at an accord among its member nations to cut crude oil production, and more importantly how to share the burden of supply cuts. OPEC ministers met on November 28th, 2016 to iron out several disagreements on how to share the burden of supply cuts. After that, OPEC will decide on the production levels of each country at its next formal meeting in Vienna on November 30th, 2016.

The OPEC, a 14-nation cartel that controls over a third of the world’s oil production, was under pressure to reach an agreement with producers outside the group as well to stabilize the market and eliminate the global oil glut, where markets continue to struggle with excess supply and crude remains capped below $50 a barrel. OPEC, which met on the sidelines of the International Energy Forum (IEF) in Algeria from September 26th-28th, 2016, agreed to reduce oil output to 32.5 million barrels per day (bpd) from the current levels of around 33.24 million bpd and pull the market out of a two-year downturn.

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Since the September 2016 meet, crude oil prices have been trading near $48 per barrel, up from under $30 a barrel at the start of 2016, but well down from the years when it was above $100 a barrel, before dropping off in mid-2014. If OPEC indeed implements the output cut in 2016, market watchers believe that the deal could add $7 to $10 to oil prices in H1 FY17, giving cause for hope to oil producers as crude prices continue their recovery from a 12-year low.

Geo-political tensions remain stumbling block

Geo-political tensions between Iran and Saudi Arabia have continued to be the main stumbling block to reaching an oil output curbing agreement among the OPEC nations. OPEC has even asked non-OPEC countries such as Russia to curb output by 500,000 barrels a day. Saudi Arabia agreed to a plan to curb output by almost 1 million bpd of oil over the next year. However, the plan would also require Iran to hold its production steady at about 3.7 million barrels a day, which Iran has rejected. Saudi Arabia is the largest OPEC producer with output of more than 10.7 million bpd, on par with Russia and the U.S. Together, the three largest global producers account for a third of the world’s oil.

An oil production cut would help oil prices to rise to $55 to $60 a barrel; however, if no agreement is reached in Vienna next week, the price may remain below $45 a barrel or plunge lower for the near-term as the global glut increases.

Oil companies witnessed biggest gain in six years

Oil companies including Exxon Mobil Corporation (NYSE: XOM), Royal Dutch Shell PLC, Chevron Corp. (NYSE: CVX), Total SA, and BP PLC (NYSE: BP) have together added $490 billion to their market value in 2016, the biggest gain in six years, following a 25% rise in benchmark Brent crude, according to Bloomberg. This follows an $850 billion loss in value in 2015 and $720 billion in 2014 as crude prices plunged below $40 per barrel. Brent crude fell as low as $27.10 a barrel in January 2016, the lowest since November 2003.

The drop in crude prices in 2014 has knocked off billions in the market value of oil producers, from giants like Royal Dutch Shell to other exploration companies. In the process, oil companies have piled on massive debts, canceled billions of dollars of projects, and slashed jobs to combat the downturn. In September 2016, the OPEC’s decision to reverse a two-year policy of pumping at full throttle and agreeing instead to cut production gave these companies a lease of life that good times could be around the corner. Hence, sustaining the gain in oil producers’ market value hinges on the outcome of the OPEC talks.

Source: Bloomberg
Source: Bloomberg

The Bloomberg World Oil & Gas Index of 58 companies is up 12% so far in 2016, the largest gain since 2009 following two years of declines. Energy companies are the second-best performers in the MSCI World Index after languishing at the bottom in 2015.

Source: Bloomberg
Source: Bloomberg

Shell and BP’s shares are headed for their biggest annual increase since 1999. Hence, every dollar increase in crude oil prices raises BP’s annual adjusted profit by about $300 million, according to the company’s website. In the interim, oil companies are reducing their operating costs by renegotiating contracts, making projects smaller, and trimming their workforce. Regardless of the outcome of the OPEC talks, oil companies will continue to focus on improving efficiency and cutting costs.

While the Vienna meet poses a cliffhanger, it now remains to be seen whether internal meetings among the member nations could result in an early resolution of differences and pave the way for a meaningful conclusion at the Vienna meet on November 30th, 2016.

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