OPEC Approves First Deal to Cut Output in 8 Years – 11/30/16

OPEC successfully agreed to some crude oil production cuts for the first time since 2008 yet the effect it has on oil prices will likely be minimal.

Oil traders and investors may cheer the deal to curtail oil production, but history shows implementation of such agreements is often imperfect. In this case, exemptions have already been granted to Iran, Nigeria, and Libya making the collective target for the group all but unreachable if those nations boost output as planned. OPEC is also relying heavily on a reduction from producers outside the bloc of 600,000 barrels a day, half of that cut coming from Russia which has produced mixed results in the past.

Even with full compliance with the quotas by OPEC and non-OPEC, Goldman Sachs expects oil prices to only rise to about $60 a barrel. Other analysts from Morgan Stanley and Wood Mackenzie similarly see prices staying in the $50 to $60 a barrel range at best.

While 20% increase in oil prices would definitely improve the financial situation of oil drillers, it pales in comparison to 2014 prices that reached above $100 a barrel. It also risks reviving the competitors that OPEC hoped to force out of the market: U.S. shale drillers.

Fracking has changed the marginal economics of oil forever. Fracking shale deposits to get at tight oil is dramatically faster and less capital-intensive than traditional oil drilling, which is why output of U.S. oil spiked in recent years. And the U.S. is likely to only produce more tight oil in the coming years, according to the EIA.

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Shale oil drillers may have been devastated during the last two years of low prices, but a revival in their output is inevitable once prices start rising again. And renewed production in the U.S. would effectively cap oil prices even if OPEC’s deal goes perfectly and make efforts to keep prices above $55 “self-defeating”, according to Goldman Sachs.

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