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OPEC Might Extend Production Cuts: Will Oil Gain?

Zacks Equity Research

Oil price determines the fortune of any energy player. So it is imperative that investors find out the price at which the commodity is trading before placing their bets on the space.

The Organization of the Petroleum Exporting Countries’ (OPEC) decision to limit production is no longer forcing oil to walk on the bullish path. In fact, the force is fading by the day as U.S. drillers have been gathering on the plays. Meanwhile, investors believe that the extension of the OPEC deal can provide a further boost to crude.

OPEC’s November Deal

The OPEC signed a deal on Nov 30, 2016, to cut oil production with an aim to recover crude from the slump extending for more than two years. Saudi Arabia decided to shoulder most of the output cut, followed by Iraq.

Iran — the country that has the fourth largest proven oil reserve in the world as per its government — was exempted from the cut. This is because the country was exempted from the sanctions last year following the historic nuke deal signed with superpowers like U.S., Russia, Britain, Germany, France, China and the EU on Jul 14, 2015, in Vienna.

Along with OPEC, non-OPEC producers like Russia also showed interest and agreed on curbing production. Eventually oil started improving and crossed the $50-per-barrel physiological mark.

Producers Comply with the Requirements

Immediately after the signing of the accord, analysts raised doubts over whether OPEC will act in accordance with the agreement.

According to media reports, the compliance of OPEC has been more than 90% as Saudi Arabia – the biggest oil producer of the cartel – has been lowering production more than promised.

The fulfillment of the terms by both OPEC and non-OPEC players has been reflected in the February oil market report by the International Energy Agency (IEA). Per the report, during Jan 2017, supply of oil in the world slipped 1.5 million barrels per day. Eventually, crude traded above $50 a barrel during the entire of January and February. This has acted in favor of energy majors like Chevron Corp. CVX, Exxon Mobil Corp. XOM, BP Plc BP and Royal Dutch Shell plc RDS.B. Chevron, Exxon Mobil and BP carry a Zacks Rank #3 (Hold) while Shell sports a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Will the Deal Be Extended?

Before delving into the need for a deal extension, it is to be noted that the effect of the November deal has been fading of late. The main reason for this is after crude started gaining traction, U.S shale drillers flocked to oil patches and bumped up production significantly.

This has nullified the impact of the OPEC deal as is evident from the recent fall of oil below the $50-per barrel mark. A record-high level of inventory in the U.S. also led to the decline. The decline in oil prices also got reflected in the downward stock price movement of Chevron, Exxon, BP and Shell.

Hence, according to several analysts, a deal extension ahead of the expiry at June-end could drive oil to the bullish territory again.

It is to be noted that Kuwait is the first member of the cartel that called for the extension. The country believes that the rally supported by the output cut has faded. However, Kuwait’s Oil Minister Issam Almarzooq commented, “It’s too early for OPEC to agree on an extension.”

Moreover, Khalid Al-Falih, the oil minister of Saudi Arabia, has shifted from its decision to extend the deal. This could be because Saudi Arabia doesn’t want U.S. drillers to capitalize on higher oil prices at the expense of OPEC again.

Conclusion

OPEC is faced with two choices now. It can either deter the deal extension or extend the production cut to help U.S. shale players pump out more oil at better prices.

Many analysts are in favor of a deal extension as the oil market is still oversupplied. In fact, according to the February report of IEA, stockpiles of crude are 286 million barrels, above the five-year average mark. On top of that, by the end of the first half of this year, crude inventory might remain well above the average mark, according to Paris-based IEA. 

Want to hear more about the recent dip in oil prices? Check out the latest episode of the Zacks Friday Finish Line Podcast:

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