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OPEC headquarters
A view of the OPEC headquarters in Vienna. By Priwo (photo taken by de:Benutzer:Priwo) [Public domain], via Wikimedia Commons

OPEC agrees to cut production, US producers prepare to respond

Have you been watching the price of oil? As this story is being written, WTI Crude sits at $51.37, up 31 cents. Yesterday, according to Reuters, Brent crude was at its highest in 16 months. Why the jump? Because the Organization of Petroleum Exporting Countries agreed to its first oil output reduction since 2008. Members pledged to remove 1.2 million barrels a day (b/d) from global oil production if non-OPEC countries, like Russia, would also participate in a production cut, which is still not solidified. The Economist reports:

The [price] rally’s continuation depends on non-OPEC members such as Russia reliably committing to cut output at a meeting on December 9th. It also hinges on the speed at which American shale producers step up production, and on Donald Trump’s dream of oil self-reliance.

The Economist also notes that Saudi Arabia, OPEC’s biggest producer, is likely to benefit despite since the price of oil is projected to increase. OPEC argues that a cut now will “spur investment in new sources of crude that will prevent harmful oil shortages in the future. Investments are key to a diversification of Saudi Arabia’s economy that will prevent the reliance on oil as the country’s only source of wealth.

The cuts will take effect January 1 and last for six months.

Even though the short-term oil market has rallied with the projected cuts, some analysts are skeptical the increase in price will be sustained. Head of the International Energy Agency, Fatih Birol, warned of “greater volatility after the OPEC deal,” Reuters reports.

“Unlike in the past OPEC decisions, if prices move to around $60, a substantial amount of oil in United states is ready to come to the markets,” Birol said.

Goldman Sachs analysts agreed, stating:

We do not believe that oil prices can sustainably remain above $55 per barrel, with global production responding first and foremost in the U.S.

The question remains, if oil prices go back up, will U.S. producers rally and increase production? Will this undo the positive impact of an OPEC cut to increase global prices, or will an increase in U.S. production have a minimal impact? It appears that U.S. drillers are waiting to see what happens with bated breath.

In San Antonio, in the heart of the Eagle Ford, South Texas Energy & Economic Roundtable President and CEO Omar Garcia told the San Antonio Business Journal that the production cuts are welcome news after two years of record-low oil prices caused by OPEC members refusing to cut production. Garcia said oil prices will need to stay above $50 per barrel to have any real impact on drilling activity. According to the Business Journal, Garcia said:

We’ve been seeing movement for the last several months, but in order for us to get back into the 50, 60 or 70 rig count, we’ve got to see sustained prices above $50 per barrel.

Vox reporter Brad Plumer discussed the complicated relationship between the OPEC cuts and the shale industry. After two years of allowing low prices in hopes that many U.S. companies would be pressed out of the picture, since shale operations are far more expensive, Saudi Arabia made a difficult decision to make the cuts, even though it was a gamble. Even though production in the U.S. has dropped significantly since 2014, shale producers in the Bakken, Eagle Ford and Permian Basin, for example, have figured out ways to cut operational costs and improve efficiency in order to operate at lower oil prices. Plumer reports:

But if OPEC successfully throttles back on production and hikes prices, that could induce some fracking companies in Texas or North Dakota to start drilling again. At that point, supply would rise and prices would fall. OPEC would be right back where it started — except it would have lost market share.

The tricky part is that no one knows exactly how this dynamic would play out.Forecasts vary wildly on how much US oil production could grow again if prices rise to, say, $60 per barrel — some analysts suggest an extra 300,000 barrels per day, others 900,000 barrels per day.

Reuters reports that OPEC will hold talks with non-OPEC producers on Dec. 9. The group will also have its next meeting on May 25 to monitor the deal, which it said it could extend for six months.

 

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