The market is in extreme rally mode this morning as the dominoes continue to fall. First we had OPEC agree to cut production on Nov 30th, then we had non-OPEC members agree to cut production, and now we have Saudi Arabia indicating it will make even bigger cuts than what it had proclaimed originally. This domino effect has caused a 20% jump in WTI crude prices, hitting a price level not seen for nearly 18 months. Also worth noting: oil is currently hovering around the $53/bbl mark, which is 50% higher than at this time last year.
Let’s recap. Beginning in 2014, Saudi Arabia begin the “pump at will” mentality and along with the majority of the world’s producers, its output began to surpass global demand, which led to an abundance of crude worldwide. Economically speaking, when supply outweighs demand, prices fall; and fall they did. Over the course of a year, prices fell from over $100/bbl to a record low of $26. Thus, come the new year of 2016, talks about the necessity of a production cut began.
Nearly a year later, in the hopes of raising the price of crude oil and bringing balance to the physical supply of product, the Organization of the Petroleum Exporting Countries has now agreed on a production cut of 1.2 million bbls per day for six months beginning January 1st, 2017, and non-OPEC members, led mostly by Russia, have agreed on a production cut of 558,000 bbls/day.
Moving forward, there are still many different outcomes that could happen in 2017. According to Reuters.com, Goldman Sachs’ 2017 forecast predicts that if OPEC and non-OPEC fully comply and cooperate in said production cuts, a $60/bbl crude price is in store. However, the market speculated and made its forecasts based upon a total production cut of one million bbls/day, and as you can see, OPEC plus non-OPEC committed production cut volume is actually 1.6 million bbls/day. Goldman Sachs believes this additional volume could equate to an extra $6/bbl increase in crude prices.
Not to be the bearer of bad news, but we cannot lose sight of what an increase in the value of crude does to production; it goes up. When the value of the product a company produces increases, the incentive to produce that product increases. “The ideal price for oil is about $60 a barrel, because any higher would unleash a surfeit of shale production,” Nigerian Minister of State for Petroleum, Emanuel Kachikwu, said in a recent Bloomberg TV interview. The truth is in the numbers. Here in the U.S. alone, the numbers of active oil rigs has doubled in the past month with this recent surge of oil prices. If propped up oil prices lead to an increase in production this upcoming year, we could then be in the same situation we are now.
In conclusion, we will just have to wait and see. Q3 of 2017 will be the pivotal point. Will prices have increased to the $60/bbl by then and will they stay there? Or after the six month production cuts will prices begin to crash back down due to an influx of production? Future blog posts will tell the tale.
WTI crude is currently up $1.67 to $53.17. RBOB is up $0.0463 and ULSD is up $0.0401