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OPEC Deal Signals a Permanent Shift in Oil Markets

Thursday, October 6, 2016 4:33
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(Before It's News)

OPEC logoCommodity analyst Michael McDonald examines the effects of the rumored OPEC production cap deal, and finds the pact represents a massive shift that has permanently changed the energy markets.

Market enthusiasm around the OPEC deal has vacillated significantly over the last week, alternating between optimism and pessimism. A healthy segment of investors view the current agreement with skepticism given the competing geopolitical interests of Iran and Saudi Arabia. And while that skepticism may turn out to be unwarranted; it is certainly possible that one or more of the OPEC members will cheat on any production agreement and overproduce, especially given the lack of effective monitoring mechanisms in place to control production.

None of that matters much though. The more significant point about the OPEC agreement that investors may be missing is the sign of shifting attitudes that it portends. An agreement between two foes as intractable as the Saudis and Iran suggests that OPEC has finally accepted an important reality – they cannot turn back time. While U.S. unconventional production has been curtailed, only a fool would believe it has been hobbled permanently. As oil prices start to rise, U.S. production will likely rise as well.

OPEC seems to have finally accepted the fact that they are not as strong as they once were, and that the market forces behind unconventional production in the U.S., Canada, and abroad are not as weak as OPEC had supposed. While a few U.S. firms have been bankrupted by the last few years, those bankruptcies have only served to strengthen top tier players in the space like Devon and Continental.

Far from shutting down U.S. production, OPEC’s actions have only helped to lower costs by putting pressure on the overall supply chain and associated prices. This has made unconventional crude more profitable at lower prices and exacerbated the problem that OPEC started with. Where unconventional crude producers once needed $80 per barrel oil prices to succeed, today breakeven levels are closer to $40.

OPEC appears to have finally given up the dream of crushing U.S. production and returning to a world in which the Cartel controlled the market. US producers may not be the lowest cost producers, but could well be the most flexible producers. OPEC’s actions did succeed in stalling new investment in future reserves development, but this hit both unconventional and conventional production in nearly equal measure.

If OPEC could have sustained a decade or more of low prices, eventually the curtailed E&P programs would have led to a structural shift in the oil markets and pushed new production down dramatically. OPEC never had that level of foreign currency reserves though. The Saudis would have needed at least $2 trillion more in reserves in order to sustain lower oil prices for a decade, and while that might be feasible for the Kingdom (with enormous asset sales and tapping international bond markets), most other members of OPEC would have run out of cash well before that ever occurred. To kill unconventional production, OPEC needed a scorched earth policy that its members were ill-prepared to adopt.

None of this means that oil is headed dramatically higher immediately or that companies will return the halcyon days of yesteryear. The market has changed. But OPEC’s production deal does signal acceptance of reality by the Cartel. Producers from the Saudis to Nigeria do not have the ability to withstand continued low prices. They are taking corrective action at this point because few options are left, and domestic political pressures are too great. Investors can capitalize on this trend. The current deal may or may not hold, but the game OPEC was playing for the last two years is coming to an end.

USO-2016-10-06

The United States Oil Fund LP ETF (NYSE:USO) fell slightly to $11.34 per share in premarket trading. The largest ETF tied to WTI crude oil prices has gained 3.18% year-to-date, but is still more than 30% off of its 52-week highs of $16.20.

This article is brought to you courtesy of OilPrice.com.

You are viewing an abbreviated republication of ETF Daily News content. You can find full ETF Daily News articles on (www.etfdailynews.com)

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