Crude Economics
OPEC Cuts Not Expected to Change Much

OPEC’s decision late this past month to cut production for the first time in eight years has so far had the desired effect: Brent crude has jumped nearly $10 per barrel, and that European benchmark and its U.S. counterpart—the West Texas Intermediate (WTI)—are now both firmly ensconced in the $50+ stratum.

But that’s still far from where OPEC’s member states—and the non-member petrostates it’s colluding with on this deal—would like to see prices. In fact, much of OPEC requires an oil price well in excess of $60 per barrel (and in some cases greater than $100) just to balance government budgets. So while this 20 percent jump in prices is a step in the right direction, it’s not far enough to bring the cartel to the ideal market its members are so desperately hoping for.

The billion-dollar question, then, is just how effective this cut can be in reducing the global glut of crude—and therefore how far it can inflate prices. Unfortunately for the Saudis and their ilk, according the U.S. Energy Information Administration (EIA), prices won’t be moving out of the $50 range next year. The EIA reports:

In EIA’s December Short-Term Energy Outlook (STEO), both the West Texas Intermediate (WTI) and Brent crude oil 2017 price forecasts increased by about $1 per barrel (b) from the November STEO, with prices expected to average $51/b and $52/b, respectively. The WTI price is forecast to average $49/b in the first half of 2017 and end the year at $54/b, while the Brent price is forecast to average $50/b in the first half of 2017 and end the year at $55/b. The forecast includes consideration of the Organization of the Petroleum Exporting Countries’ (OPEC) recent announcement to reduce production. However, the agreement only resulted in small changes to the STEO forecast.

Those forecasts for those two important benchmarks for next year are actually lower than where Brent and the WTI currently reside. We should note that oil market forecasts are notoriously unreliable, for the simple reason that any number of events, foreseeable and unforeseeable, could jerk prices in one direction or another. That said, the fact that the EIA is anticipating such a mild medium-term effect of OPEC’s cut on the market should be deeply worrying to petrostate oil ministers the world over.

One of the biggest variables working against a large and lasting price rebound can be found here in the United States. As the EIA explains, now that the market is trending upwards again, shale producers are eagerly preparing to reopen projects shuttered during the crude price collapse:

A price recovery above $50/b could contribute to supply growth in U.S. tight oil regions and in other non-OPEC producing countries that do not participate in the OPEC-led supply reductions. Crude oil prices near $50/b have led to increased investment by some U.S. production companies, particularly those operating in the Permian Basin in Texas and New Mexico.

This was always the biggest weakness of any decision by OPEC to constrain supplies in an effort to counteract sliding prices these past two and a half years. And it’s precisely why the Saudis held out against supporting a cut for so long. Desperation, however, forced Riyadh’s hand, and now OPEC looks set to cede market share without fully capitalizing on rising prices. For those petrostates, this is the worst-case scenario. For American shale producers, however, it’s starting to feel like a boom once again.

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