OPEC’s surprise production cut looks likely to have an outsize impact on the oil market, elevating prices for months—or even years—to come.
Even after oil prices surged on Monday following OPEC’s announcement, prices remain well below their highs following Russia’s invasion of Ukraine in February 2022.
Brent crude,
the international benchmark, peaked at $139 in March and averaged $100 for the year. By contrast, Brent was trading at just $85 on Monday, despite rising 6% on the day.
Still, the move by OPEC and its allies to cut production could actually have a larger long-term impact on oil price dynamics than Russia’s invasion. And it looks likely to revive some interest in oil stocks, which have fallen out of favor. One main reason is that OPEC is cutting production just as demand looks set to surge, a dynamic that sets the stage for tight supply well into the future.
Few events in the past decade have changed energy markets as much as Russia’s invasion. There’s no doubt its impact on geopolitics is enormous. But its impact on prices now looks more short-lived, even if it was more dramatic. After the invasion, some analysts had predicted prices might spike as high as $200 in the near-term. Instead, after peaking in March, prices fell through the end of the year.
By comparison, OPEC’s latest move hasn’t led to short-term predictions of $200 oil, but it does set the stage for higher prices for some time. Raymond James analyst John Freeman now sees oil rising to $105 per barrel by the fourth quarter.
Goldman Sachs
upped its December 2023 price target to $95 from $90, and sees oil prices at $100 in December 2024, up from its prior forecast of $97. OPEC’s willingness to step in now, when prices were already relatively high, is a strong sign that the cartel is now placing a “floor” of $80 on prices, above the previous $60 level it seemed willing to defend, according to
Bank of America
analyst Doug Leggate. Before OPEC made its latest move, analysts had started to doubt whether the group would defend these prices.
If investors can count on $80 oil, Leggate sees an average of 30% upside in oil stocks. He thinks the stocks have been discounting prices closer to $66. Among his favorite oil-weighted names are
Exxon Mobil
(XOM),
APA
(APA), Hess (HES),
Occidental Petroleum
(OXY), and
ConocoPhillips
(COP).
Obviously, last year’s $100-plus prices were more profitable for oil companies than current levels around $85. But current levels now look more sustainable.
Oil companies tend to prefer prices that are relatively strong and stable, instead of uneven spikes and dips, even if the spikes send prices to multiyear highs. Stable prices make planning easier and attracts investors who like stable dividend stocks and don’t have to worry that they may be buying in at a peak.
The production-cut policy put in place by OPEC and its allies looks likely to lead to persistently strong prices. The cut is expected to start in May and amount to more than 1 million barrels a day, or somewhere between 1% and 2% of the oil market, through the end of the year. The biggest reason it could have a longer-lasting impact on prices than Russia’s invasion is because the setup for oil demand is very different than it was a year ago. Russia’s invasion did unsettle oil markets and lead to sanctions against its exports, but the basic supply-demand picture didn’t change much. Russia was able to reroute oil away from Europe and the U.S., keeping overall global supply high. And China’s Covid restrictions in 2022 took a big bite out of global demand for oil. By the end of the year, oil storage tanks were filling up with barrels that people didn’t need. Oil supply exceeded demand by 500,000 barrels a day by the fourth quarter of 2022, Freeman estimates.
This year, demand is poised to surge as China reopens. Freeman expects demand to jump by 3 million barrels a day from the first quarter to the fourth quarter, turning a glut into an undersupply. By the fourth quarter, the market could be undersupplied by 2 million barrels a day. Consumers will need all the crude that built up in storage tanks last year, and they will have to pay up more for it.
There are other reasons OPEC’s cuts could have a persistent impact.
The cuts come at a time when investors have less interest in oil and oil stocks than they have in months. Underinvestment in the sector means that there is still room for more people to get bullish. “Positioning in crude is EXTREMELY light after the recent financial market driven weakness,” wrote Rebecca Babin, senior energy trader at CIBC Private Wealth US.
Babin also thinks OPEC’s latest cuts are significant because the countries cutting production actually have the wherewithal to do so.
“Unlike cuts in the past that were more ‘paper cuts’ to quotas with many countries already producing below quota, these are REAL voluntary cuts from countries producing at or above quotas,” she wrote. “That means the market impact will be far more impactful than the 2 million barrels cut we saw in October of 2022.”
OPEC hasn’t always succeeded in controlling the market. This time, its impact is likely to last.
Write to Avi Salzman at [email protected]
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