Is It Time For Crude Oil Prices To Recover?

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The commodity downturn that began in 2014 has entered into its third year of devastation. The commodity markets went into a slump in the second half of 2014 due to the oversupply of oil in the global markets, caused by the Organization of Petroleum Exporting Countries’, also known as  the OPEC, decision to maintain high production levels to defend their market share against the booming tight oil production in the US. The result was that the world witnessed its worst ever commodity trough.

However, having pushed several US shale producers out of business for over two years, the OPEC members have now started feeling the pinch on their economies that are highly dependent on oil exports. Consequently, the market expected the organization to reach a consensus on the freezing or reducing of their record oil production when it last met in June of this year. But, the members of the cartel were unable to find a common ground due to Iran’s resistance to abide to a production quota as it emerged from years of international sanctions in January this year. This caused uncertainty in the commodity markets and prevented crude oil prices from recovering over the last few months.

OPEC meeting

Source: Bloomberg

The prolonged weakness in crude oil prices has led to a drastic decline in the revenues of the OPEC countries and put a strain on their fiscal position, hindering their economic growth. As a result, the members of the world’s largest cartel held a special meeting on 28th September 2016 in Algeria, ahead of its scheduled bi-annual meet in November, to reconsider its stance of “market share first” strategy in the oil markets. While Iran’s unwillingness to cap its production had resulted in a 3% drop in oil prices earlier this week, the oil cartel finally agreed on a ceiling for its oil production at the meeting. With an objective to stabilize oil prices, the OPEC countries has reached an understanding to restrict their combined oil output between 32.5 and 33 million barrels per day. This implies a potential reduction of 200 to 700 MBPD (thousand barrels per day) compared to the record high output in August, provided all the member countries adhere to this limit.

While no definitive agreement was signed this week, a formal deal, detailing out the production quota for each member and other details, is likely to be reached in the OPEC’s next meeting, which is scheduled for the 30th of November. The understanding that was arrived at the Algeria meet is OPEC’s first planned output cut in eight years and is likely to create a dent on the global crude glut. However, the intensity of the dent could vary depending upon the seriousness of the member countries towards the arrangement. The market is skeptical about the successful implementation of the production cap as the OPEC countries have a track record of breaching such agreements.

Nonetheless, assuming that all the OPEC members would produce oil within the agreed limits, crude oil prices could rebound by $5-$7 per barrel compared to its current price over the next few quarters. However, an increase in oil prices beyond this limit could reinstate the US shale producers to grow their production at a faster rate, as it would become economically viable for them to do so. This could dilute the impact of OPEC’s move to cut output to improve oil prices. Thus, the terms of the agreement, and the intent of the OPEC countries to abide by these terms, will play a crucial role in the quantum of recovery in crude oil prices over the next few quarters.

Stay tuned for our next analysis – Is $45-$55 Per Barrel The Goldilocks Range For Crude Oil Prices? – where we will explain why we believe that crude oil prices will remain in this range over the next few quarters.

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