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Oil Update–November 2016

Those of us who follow oil know that at the end of November, OPEC will hold a meeting and will decide whether to follow through on its Algiers commitment to reduce members’ oil production. Most articles in the major financial newspapers indicate that many analysts, traders, and speculators are skeptical, if not dismissive, that OPEC will follow through. I, however, think that OPEC will announce a reduction, though I am not certain that it will be as large as many hope.

Helima Croft of RBC Capital Markets Research wrote a report, which Barron’s cited in an article “OPEC Must Strike Deal For Its Own Good” (subscription required), with the following key points:

  • Revenue is the key item for all concerned;
  • Saudi Arabia—the pivotal player in OPEC—wants a deal done for domestic reasons;
  • Because most members are at or near maximum capacity, the opportunities for cheating are constrained;
  • A sustainable increase in production for Croft’s “fragile five” looks challenging in the near term;
  • OPEC is aware of extremely adverse price and reputational risks from failure to reach an agreement; and
  • The election of Donald Trump should not dramatically alter OPEC dynamics.

I agree with all of her points.

The Wall Street Journal article “Oil Prices Await Effect of OPEC Deal” (subscription required) mentions the prices that banks expect for 2017.

Underscoring the uncertainty about the deal’s prospects, banks polled by The Wall Street Journal kept their price forecasts largely unchanged from the previous month. The 14 banks in the survey predict that international Brent crude will average at $56 a barrel next year while U.S. benchmark West Texas Intermediate will average $54 a barrel next year.

On Friday, Brent was trading at $48.54 a barrel while WTI was at $47.60 a barrel. Those prices are still down by more than half from mid-2014.

OPEC agreed in September to reduce its record output, but its members have since increased production even more, complicating its calculations for a cut. That means the nitty-gritty details of any OPEC agreement on Wednesday will be more important than usual.

The banks’ prices are likely a sweet spot—high enough to make a substantial difference in producers’ revenue while low enough to prohibit higher cost oil assets from being exploited.

For those of us interested in the oil markets, Wednesday should prove to be an interesting day.

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