Big OPEC-ing deal!

December 1, 2016 08:32 AM
Daily Energy Market Analysis

This is a big OPEC’ing deal. While the naysayers said it could not be done, OPEC went ahead and did it anyway. The cartel agreed to cut production by 1.2 million barrels a day(mbd) to 32.5 mbd and has enticed non-OPEC producers to add another 600,000 barrels. Now that the months in making the deal is done, what does this mean for oil as well as the outside market.

Well, first, I don’t think you can doubt OPEC's commitment to making these cuts work. Not only will they have OPEC countries monitor compliance, they will also have an independent group count the barrels. In other words, they will have monitors montoring the monitors. Kuwait, Venezuela and Algeria will be montoring compliance and a disinterested third party will be keeping score of the barrels produced.

Besides, it would be a mistake to cheat on output when you must get non-OPEC players like Russia to cut. The Russians have said they will cut 300,000 barrels of oil a day but they will so gradually. I am sure they are doing it gradually to make sure that other OPEC countries are going to comply. If Russia sees that OPEC is not taking steps to reduce output, they will not follow through on their cut of 300,000 barrels a day. You can’t compare this to typical OPEC cuts. Remember, this is not just an OPEC Deal, this is a OPEC/non-OPEC deal and the last time that happened in 2002 oil was at a bottom.

At the same time, the same folks that said OPEC would not get a deal done are now saying that a deal won’t hold. They say that this will just allow a flood of shale oil to come back onto the market thereby negating the OPEC/non-OPEC production cut. While it is true that this production cut will give a boost to shale, it will take at least a year for U.S. oil production to get back to where production was a year ago.

U.S. production is still down a million barrels a day from last year and that is not going to comeback overnight, while it is true that U.S. shale producers have learned to cut costs many of them are still deep in debt. Many of the rigs that have been added lately are to replace rigs that are in decline or to make sure that they don’t lose their lease where they are contractually obligated to use it or lose it. This myth that we are just going to flip a switch and raise output by a million plus barrels to fill the void created by the OPEC cut is just not in the land of reason.

We will see a scenario where demand is going to rise. The Energy Information Administration just reported September oil demand was up 2.3% above year ago levels. U.S. oil demand in September rose by 2.3%, or 446,000 barrels per day (bpd), from a year ago, to 19.86 million bpd. Gas demand increased by 2.2 percent, or 203,000 bpd, from a year ago, to 9.49 million bpd in September, the data showed.

Data out of China suggests that we are seeing expansion in their manufacturing sector that suggests that the recent trend of strong Chinese oil demand will continue. The Chinese Federation of Logistics and Purchasing showed that Chinese factory activity rose to 51.7 in November, its highest reading in more than two years. Even with the stronger dollar the trend of higher demand in China looks poised to continue as the outlook for global growth is increasing. 

You can’t compare this cut to 2008, when the global economy was crashing and OPEC cut production in a futile attempt to increase prices while the global economy was falling apart. The move backfired on them as demand dried up and they actually added to the economic doom. It was the Fed and quantitaive easing that brought oil back up, not the cartel. This time the move should help revive a market that was artificially depressed as OPEC members sold oil at a loss just to drive down prices and put shale players out of business. This cut will be welcome and it should allow US producers to get back in the game overtime but not overnight. The bull market in oil is strong and we should see oil test near $60.00 a barrel. 

Today we get the natural gas report! I think we could see a bullish withdrawal of 65 bcf.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.