Although an OPEC agreement has been reached, future obstacles remain

December 4, 2016

By: Alexander Karpenko

On Wednesday, November 30th, the Organization of Petroleum Exporting Countries (OPEC) agreed to cut production for the first time since the 2008 Financial Crisis. The announcement signals a shift in OPEC’s stance, which over the past two years has focused on expanding market share, returning to its traditional role of managing markets. The agreement calls for a cut of 1.2 million barrels per day (mbpd) for six months, beginning 1 January 2017, conditional on non-OPEC countries such as Brazil, Mexico, and Russia cutting an additional 600,000 bpd of production. The details of the 600,000 bpd cut are scheduled to be finalized between OPEC and non-OPEC members in a meeting on December 10th.

 

While the announcement has lifted prices in the near-term, with West Texas Intermediate (WTI) closing at $51.63/bbl on Friday, recent changes to market fundamentals could significantly mitigate OPEC’s ability to influence prices in the long-term. These changes include the increase in US tight oil production and bloated global inventories.

 

Although US oil production has been continually decreasing over the last seven quarters due to falling oil prices, weekly US field production figures from the US Energy Information Administration (EIA) suggest that US production began to ramp up in October 2016 as prices recovered. Falling from a record production high of 9.6 mbpd in June 2015 to 8.4 mbpd in August 2016, more recent EIA figures from the week of November 25th confirm that the US energy industry has increased production to 8.7 mbpd. The 1.1 mbpd decline in production from the June 2015 record high is attributed to a drop in tight oil production, which is more sensitive to prices than conventional oil. However, given the binary nature of tight oil wells, it is clear that some of this production has already come back online. According to consultancy Wood Mackenzie, for each US1$ increase in the WTI price per barrel, an additional 1.8 billion barrels of US tight oil becomes economically viable. Since May, when rig activity in the US was at its lowest, US rig count has increased by over 45% from 404 to 597 rigs on higher oil prices. Further, the US Energy Information Administration (EIA) indicates that there are over 4,100 drilled but uncompleted tight oil wells that can be brought on-line rapidly in response to unexpected increases in price.

 

Perpetually depressed oil prices have also driven record increases in US crude inventories to an all-time high of 502 million barrels (M bbls) in May 2016, well above historical averages of 300M-400M bbls. However, if prices continue to recover, these excess crude oil inventories could provide an additional source of supply and may limit the potential for price increases in the short- to medium-term.

 

Nevertheless, as a net oil exporter, Canada’s energy sector stands to benefit from an increase in global oil prices due to higher per barrel profitability. While prices are a fundamental driver of future investment and production growth, in the near-term they do not materially impact the level of Canadian production and exports. Oil sands are long-term projects that are less sensitive to short-term price fluctuations. Despite the volatility in prices experienced since the beginning of the year, oil sands production is still expected to grow by 30,000 bpd in 2016 and 250,000 bpd in 2017 as new projects are brought on-line.

 

While the OPEC agreement will provide some temporary relief to producers, it is not expected to have a material impact on market fundamentals in the medium-term, given record high stock levels and the potential for renewed US tight oil production.

 

 

 

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