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Will Russia & OPEC's Production Curb Continue?

Zacks Equity Research

On Feb 1, 2018, Goldman Sachs GS predicted that the average price of Brent crude would cross $80 a barrel in 2018. The investment bank backed this claim with the assumption that U.S. producers would not be able to meet rising global demand for oil. Further, OPEC and Russia’s deal on production curb would further push prices higher. However, on closer examination, such a claim does not seem credible.

Shale producers in the United States are on track to surpass the 11-million barrels per day threshold this year. Moreover, the most-recent oil rally will only encourage shale producers to ramp up drilling and production. Lower production costs and cost-effective technology will also boost shale production.

Finally, increasing shale production has heated up global markets as compliance to the OPEC-Russia production curtail deal means that compliant countries would have to keep curbing production even as prices rise and inventories dwindle. Speculation that the production curb deal would be breached has also surfaced. Under such circumstances, when prices fall in the future, it is difficult to digest Goldman’s claims since prices could find little support in the future.

Oil Price Performance

Oil prices have shown an uptick in the recent past. As of Feb 13, 2018, WTI crude traded at $59.65 a barrel and Brent crude traded at $62.99. 

However, a look at the price movements of some of the major U.S. and non-U.S. based players operating in the space, reveals a decreasing trend in prices over the last three months. The graph below explains the price performance of oil companies that include Chevron CVX, Exxon Mobil XOM, Royal Dutch Shell RDS-A and BP plc BP. Each of these companies possesses a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The graph clearly shows that prices of these major oil players have significantly plummeted in the last three months. Prices of U.S.-based Chevron and Exxon fell 3.2% and 8.6%, respectively. On the other hand, global players like Royal Dutch and British Petroleum dipped 1.4% and 1.9%, respectively. In the long run, prospects for such companies seem bleak because oil prices are set to plummet further.

U.S. Shale Production on the Surge

With Brent crude hitting a near three-year high recently, market watchers have become largely optimistic about the fact that global oil output restraint will eventually push the Brent above $70 a barrel. However, increasing shale output poses a direct threat to the occurrence of such an event. OPEC and its allies continue to lose market share to shale producers in the United States.

On Feb 7, 2018, the U.S. Energy Information Administration forecast that crude production is likely to increase more than 1.2 million barrels per day by the end of 2018. Such a forecast comes on the back of an unusual increase in U.S. onshore production.

Moreover, this forecast was a revision from less than 103 million barrels per day, which was predicted in January 2018. Finally, crude production from shale is expected to rise by 1.25 million barrels per day in 2018.

On Jan 9, 2018, it was predicted by the EIA that the United States would surpass 11 million barrels per day threshold not before November 2019. However, the most recent report suggests that this will happen in 2018 itself. Also, the 10-million-bpd threshold that producers were expected to cross in February was actually crossed last November.

Most importantly, shale has low breakeven costs and WTI is currently trading at almost $60 a barrel. This is certainly going to encourage producers to ramp up oil production even more. Finally, regularly better fracking technology and cost-effective equipment will boost production further.

Will the Russia-OPEC Deal Break Down?

Russia and the OPEC had agreed on Nov 30, 2017 that it will extend oil production cuts till the end of 2018. This was done to reduce oversupply of crude. These major producers had estimated that if the target is achieved before the deadline, the deal would be discontinued to avoid possible overheating of the global oil market.

More importantly, the organization had jointly agreed to cut oil prices in order to compete with demand for U.S. shale. Such an event can lead to overheating in OPEC and other ally countries due to falling inventories amid high prices.

Now, OPEC and its non-member allies have, for the thirteenth month on the trot complied with the terms of the production curtail deal, which by far has been successful. However, some economists are speculating a possible breach of the deal. This could be due to global pressures from higher oil prices amid production cuts. At the same time, these countries could feel the heat of rising U.S. shale supply because that poses a direct threat to oil prices and therefore the respective market share.

Both Russia and OPEC adhered to the terms of the deal in January. Russia in particular, kept production flat at 10.95 million bpd. While Russia’s compliance to the agreement was 100%, OPEC’s compliance with the production cut agreement was 127%.

According to the oil and gas director at Fitch Ratings in London, Dmitry Marinchenko, Russia would comply with the agreement close to 100% in 2018, oil companies in the country present a different picture. Companies in Russia operating in the space have been largely wary of the production curbs deal as it directly prevents them from increasing production even as oil prices continue to rise globally.

To Conclude

Under production curtail wherein oil prices stay above $60 and inventories keep dwindling, Russian oil companies might be enticed ramp up oil production and drilling, thereby breaching the agreement in the process. Finally, there seems to be no stopping U.S. shale producers from curbing production. Further, when shale production eventually nears 11 million bpd, Brent crude is most unlikely to top $80 a barrel. This is why it is likely to become increasingly difficult for Russia and the OPEC to adhere to the production cuts agreement.

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