OPEC managed to convince almost a dozen non-OPEC producers to take part in oil production cuts over the weekend, and the news immediately sent international benchmarks higher, prompting a fresh wave of bullish forecasts.
The latest, by hedge fund manager Pierre Andurand, is that crude will reach US$70 by June 2017. Andurand made this call before the weekend deal between OPEC and external producers was announced, noting that the Vienna agreement reached among the members of the organization was a “major turning point”.
Three months ago, Andurand had forecast that crude would reach US$60 by the end of the year and US$70 in 2017, so he’s now just repeating his earlier prediction, with a sounder basis this time. Back in September, he had said that Saudi Arabia is aware of the long-term implications of a depressed oil market and was ready to take steps to avoid a deficit in the longer run.
The hedge fund manager is not alone in thinking the ultimate goal of the cuts is to restore the balance between demand and supply: Goldman Sachs said in a note from Sunday that the deal reached by Saudi Arabia and the 11 non-OPEC producers is aimed at helping trim down the glut rather than just propping up prices. The non-OPEC group includes countries such as Azerbaijan, Kazakhstan, Mexico, and Brunei, as well as Sudan and South Sudan, plus Malaysia and Bahrain.
What’s more, Saudi Arabia said it is ready to go above and beyond its pledge for the OPEC deal and cut production to below 10 million bpd. This statement by Oil Minister Khalid al-Falih also had an immediate effect on prices, suggesting the largest producer in OPEC was determined to bring markets back to balance no matter what it takes.
It looks like tactics are changing on the fly. Earlier this year, everyone was scrambling to maintain its market share—OPEC and non-OPEC alike. Now, the priority of maintaining market share has yielded to the priority of lifting prices and plugging budget holes.
There is a chance that this tactic will work, though it will probably take more than six months. While some are cutting, others are building, including the U.S., Nigeria, Libya, and Iran, and it’s also uncertain that all parties to these two deals will keep their word.
U.S. shale producers are ready to start pumping more the moment prices inch up, and are more than likely to do just that. They’ve already started hedging against price risks in 2017 and 2018, which means not just downward pressure on current prices, but also higher likelihood that shale output will rise further. Also, most shale boomers have substantial debt piles to deal with, which is further motivation to increase production.
Nigeria, Libya, and Iran have been allowed to continue increasing their output, and while Nigeria and Libya have internal problems that might interfere with immediate production growth plans, Iran is already welcoming Western companies back into its energy industry – something that a lot of analysts believed was unlikely to happen because of mutual mistrust.
At the same time, however, underinvestment resulting from the price crash is lending upward potential to prices, and is contributing to a rebalancing of the fundamentals. It could turn out to be the single decisive factor determining the success of OPEC’s efforts. However much energy companies talk about diversifying into renewables, most of them are ready and willing to up production the moment prices inch up. However, over the last two years, the global energy industry was hit hard by the price crash, with little cash for new investments of substantial magnitude.
Of course, underinvestment could be good for prices, pushing them up significantly higher than any OPEC deal, as fundamentals trump speculative price fluctuations at the end of the day. But there are now alternatives to fossil fuel energy, and the world may intensify its drive to adopt these alternatives instead of paying US$140 per barrel of crude again, should prices tick up too much.
Sticking to reasonably high prices is the most sensible thing to do for both OPEC and non-OPEC producers, and it looks like this is exactly what they are trying to do.
This article was originally published on Oilprice.com.