Opening the Oil Spigot: Why OPEC May Ease Production Cuts and the Impact on Energy Stocks
Research Analyst Noah Barrett explains why OPEC may ease production cuts and what that means for investors.
The Organization of the Petroleum Exporting Countries (OPEC) and Russia have said they might ease production cuts in the second half of 2018. Why?
Since 2017, OPEC and certain non-OPEC producers, such as Russia, have undertaken coordinated production cuts to help lift oil prices. The effort has been effective, with crude prices rising appreciably over the past year. But the Trump administration’s decision to reimpose sanctions on Iran helped send Brent crude above $80 per barrel in May, the first time it has done so in three-and-a-half years. A drop in output from Venezuela has also weighed on global oil supply. To alleviate these supply disruptions and keep crude from potentially spiking, OPEC and Russia have said they might consider reducing production cuts during the cartel’s June 22 meeting.
This change is notable, but I still think supply/demand fundamentals for crude remain strong. I also don’t think it changes the positive backdrop for energy stocks in 2018 and beyond.
Why is that?
OPEC and Russia could be signaling that they want to support oil demand. However, I think the demand story looks quite positive for 2018 and 2019, even if Brent were to hit $85 or $90 per barrel. This year, the International Energy Agency expects worldwide oil demand to climb by 1.4 million barrels per day, thanks to a sound economy. Should higher oil prices weigh on that figure slightly, it would still be a healthy demand environment, a positive for energy stocks.
Could a reversal in OPEC’s policy cause oil prices to retreat to the lows of 2016?
I don’t think so. If OPEC and Russia reverse their existing policy, they’re likely to add only 300,000 to 800,000 barrels per day to global output. Already, the cartel is producing about 800,000 barrels below their coordinated quota, so technically these countries would not be in violation of the existing policy if they brought back the higher end of that expected range. In addition, the more supply that comes back from OPEC and Russia, the less spare capacity there is in the market. Should there be a supply shock, oil prices could rise materially, a scenario that the cartel likely wants to avoid.
To read more about the current supply/demand environment for oil and how it’s impacting energy stocks, please see the June 2018 version of Janus Henderson’s Global Sector Views.
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Footnote: The energy industries can be significantly affected by fluctuations in energy prices and supply and demand of energy fuels, energy conservation, the success of exploration projects, and tax and other government regulations. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.
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