If you think that OPEC’s tentative decision last week to reduce crude output will boost prices even further, be prepared to be disappointed.
There’s more chance of it failing than succeeding, with many tough questions yet to be answered.
That’s the view of CBA commodity and energy analyst, Vivek Dhar, who suggests that “the biggest roadblock is the upside risk to OPEC oil supply as Iran, Iraq, Libya and Nigeria have all signaled plans to boost output before the agreement”.
Here’s a snippet from a research note released by Dhar explaining the reason for his caution:
With Iran, Libya, Iran and Iraq threatening to add around 1 million barrels per day (mb/d) in the short term, other OPEC members may have to take deeper production cuts to meet the group’s output target of 32.5-33mb/d. Saudi Arabia, the largest and most dominant member of OPEC, may have to take a greater share of the output cut, a decision that will be hard to stomach as the kingdom is allowing its arch-rival Iran to continue to boost output. A deal to freeze oil production amongst OPEC members in April failed because Saudi Arabia wanted all OPEC members, including Iran, to agree to the deal.
Alongside the threat posed by a lack of cohesion from OPEC members when they meet on November 30, Dhar suggests that “the US shale oil industry is another consideration”.
“Even if OPEC manage to agree to a deal and boost prices above US$50/bbl, there is every chance that US will deploy rigs and boost production at those price levels.
“US oil rigs have increased 34% since late May despite oil prices remaining in the US$40s.”
This chart from Dhar shows the lag effect that US crude output has to the number of oil rigs in production.
Given the unanswered questions surrounding the tentative OPEC agreement and the threat posed by the US shale oil industry, Dhar believes that OPEC’s agreement “probably has more chance of failing than succeeding”.
No only that, he suggests that in the unlikely scenario that a firm deal is struck, it may see OPEC lose market share — currently around 40% of total global production — placing a cap on prices.
“Even if it did [a firm agreement by OPEC member be reached], the ultimate unintended consequence for OPEC may become a reality – they concede market share to US and prices remain subdued.”
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