OPEC agrees to a production decrease, prices increase – but could be just right

Commentary by Marita Noon

At the end of September, the Organization of Petroleum Exporting Countries (OPEC) surprised the markets by agreeing to a production cut. As soon as the 14-nation deal was announced, oil prices jumped more than 5 percent to some of the highest levels since the crash two years ago. (Editor’s note: Locally prices at the pump are relatively unchanged because the area was mildly affected by the Alabama pipeline break earlier in the month, so prices were just beginning to recover.)

The proposed output cap is historic and represents a shift in the “pump-at-will policy,” as Bloomberg called it, “the group adopted in 2014 at the instigation of Saudi Arabia.”

Many analysts see that the Saudi gamble, aimed at putting American producers out of business, has failed. While U.S. oil production is down from last year’s highs and bankruptcies are up, the industry has become more efficient and the cost of extracting oil from shale is continuing to come down – resulting in the sixth straight week of an increased rig count and the 15th without a decrease. Wall Street Journal (WSJ) reports: “Many oil producers believe drilling in some U.S. regions can be profitable even with oil prices in their current range of $40 to $50 a barrel.”

Additionally, U.S. crude stockpiles have fallen for the fifth consecutive week – as have crude imports. American drivers are consuming more gasoline than ever. Exploration budgets, due to the low oil prices, have been slashed with the predicted result of lower production in the next few years. It appears that demand is catching up with production and prices have been creeping up since February’s lows. Phil Flynn, senior market analyst with the PRICE Futures Group explains: “While supply is still at a historically high level for this time of year, strong U.S. demand and rising U.S. exports are cutting down the glut.”

Meanwhile, the social costs of low-priced oil have been high for OPEC members – hitting Saudi Arabia especially hard. The cartel’s biggest producer has lost billions of dollars of revenue, which has resulted in a 20 percent pay cut for its ministers, reductions in financial benefits for government employees, and an increase in fees and fines, and cuts in subsidies, for all in the kingdom. Fear that the loss of the coddled lifestyle could throw the country into chaos, according to industry veteran and consultant Allen Brooks, likely convinced Saudi Arabian officials to moderate their position. The view from Bloomberg concurs: “Saudi Arabia’s willingness to do a deal, in particular, demonstrates the economic pain lower oil prices has caused producers.”

Iran, OPECs other majordomo, has, due to sanctions, gotten used to austerity and is now seeing its economic pressures easing and its oil exports increasing. It, therefore, heading into the OPEC meeting, appeared to be rejecting the Saudi output offer and dashed hopes of a compromise to cut crude production. The Financial Times quotes one Gulf OPEC delegate as saying: “All producers are hurting.”

The surprise came on Wednesday, September 28, when, after two years of failed attempts at an agreement and months of dialogue leading up to the meeting, “Saudi Arabia agreed to take on the bulk of OPEC’s proposed cuts,” wrote the WSJ. The headline from the New York Times read: “OPEC agrees to cut production, sending oil prices soaring.”

The proposed cuts are moderate in reality, only 1-2 percent of the 14-nation cartel’s 33.2 million barrels a day of production and they represent less than 1 percent of total global production. Yet, the announcement buoyed markets and added power to the previously mentioned price momentum. According to CNN Money, the agreement offers “powerful symbolism.”

While the price of oil received a bounce from the news that has given the industry cautious optimism, it is not expected to have a big impact on the price of gasoline. Oil prices are now expected to stay near $50 a barrel through the end of the year and below $60 a barrel through 2017 – which will likely mean an increase of a few cents a gallon at the pump. Julian Jessop, chief global economist at Capital Economic, in CNN Money, called the situation “a period of ‘Goldilocks’ oil prices” – low enough to help consumer spending and “high enough to keep major producers afloat.”

The slight bump in prices the proposed deal adds to the upward trend is enough to send some producers back into the oil field and encourage another burst of drilling. That increased production will have a self-leveling effect on prices. As prices go up, production increases. As more oil enters the already-glutted market, prices come down.

Additionally, the OPEC agreement is only a plan. It isn’t finalized. That could happen in Vienna in November if, and it is a big if, the members can agree on who will make the cuts, when the cuts will go into effect, how long they will last, and how they will be enforced. While all 14 countries – and non-OPEC producers such as the U.S. and Russia – will benefit from higher prices, no one wants to be the one taking the cut. Iran, Libya, and Nigeria are all trying to increase production that has been stifled due to sanctions or conflict. Plus, as WSJ reports: “OPEC has a long history of agreeing to production cuts, only to have the pact collapse when countries change their minds.” CNN Money adds: “cartel members also have a tendency to overshoot production quotas.”

So, while the OPEC announcement is “not a game-changing move that will send oil prices shooting back up towards the $100 a barrel level,” as The Guardian reported, it is big news that brightens prospects for the energy industry while keeping things just right for consumers.

The author of Energy Freedom, Marita Noon serves as the executive director for Energy Makes America Great Inc., and the companion educational organization, the Citizens’ Alliance for Responsible Energy (CARE). She hosts a weekly radio program: America’s Voice for Energy – which expands on the content of her weekly column. Follow her @EnergyRabbit.

What’s up with prices at the pump and why it could be a good sign

Commentary by Marita Noon

All of us loved less-than $2 a gallon at the pump. AAA reports: “Americans paid cheapest quarterly gas prices in 12 years” – which resulted in savings of nearly $10 billion compared to the same period last year. However, oil (and, therefore gasoline) has been creeping upward since the February low – topping $45 a barrel, a high for the year. And that could be a good thing.

While low prices at the pump have been a boon to consumers, the plunge in oil prices has been a bust for American producers.

You may not care about “big oil,” but there’s still reason to be positive about the rising prices.

There are several causes for uptick. First is the weaker U.S. dollar. As oil is traded in dollars, a weaker dollar means that it takes more of them to buy the same amount of oil.

Additionally, we are heading into a busy summer driving season and refineries are switching to the more expensive “summer blend.” The switch typically means a brief shut down for maintenance – which reduces the gasoline supply. Summer driving increases demand.

Globally, oil production is down due to a workers’ strike in Kuwait that took about 1.3 million barrels a day of production offline, and disruptions in Iraq, Nigeria, Venezuela, and the North Sea. Former investment advisor and financial writer Tony Daltorio writes: “That brought the total to roughly 3 million barrels a day that were offline.” In the U.S., according to the Wall Street Journal (WSJ), “oil production has fallen below 9 million barrels a day in recent weeks, down from a peak of 9.7 million barrels a day last April.”

These are all supply issues that can easily be eradicated with increased production – such as recently threatened by Saudi Arabia’s Deputy Crown Prince Mohammed bin Salman. Additionally, in the U.S., reports Bloomberg: “Drilled, uncompleted wells could return 500,000 barrels a day back to the market.” The potential for increased production has many, including Daltorio, predicting a fall in price from current levels.

Consumers like lower prices, but they signal economic concerns as the price of oil is directly connected to the global economy.

In February, a Citibank strategist warned that due to the extended oil price collapse, the global economy “appears to be trapped in a death spiral.” Eric Sharpe, Publisher at Energy Ink Magazine, states: “Citi’s assessment is clear, and easy to understand: weak global growth results in continued depressed oil prices as demand weakens under over-supply.”

This is why I posit higher prices are a good thing for everyone, not just the oil industry.

Simple economics are based on a supply vs. demand formula. So far, I’ve mostly addressed the supply side. But a careful read of the forecasts indicates an increase in the demand side. Sharpe points out: “The single most important factor for the stabilization of oil prices is for demand to outpace growth which it has not done for over two years. Though demand growth is slow, it is still climbing.”

On April 23, the Financial Times reported that commodities, led by oil, rallied “on signs of stronger growth” that bolstered demand. It also referenced: “better housing and infrastructure demand after China’s economy rebounded in March.”

On April 27, in a story about the price of oil hitting “another 2016 high,” WSJ addressed the fact that the Federal Reserve officials “left interest rates unchanged.” The last time the same decision was made, the statement included language that indicated the global economic and financial conditions posed risks to their outlook. This time, that was removed – “signaling less concern about risks posed to the U.S. Economy by global financial conditions.” In WSJ, Robert Yawger, director of the futures division at Mizuho Securities USA, is quoted as saying: “The elimination of international elements in the language may mean that the market feels that the international situation is improving, and we’ll get a bit of demand from emerging markets which wasn’t there.”

Additionally, Phil Flynn, Sr. Market Analyst at the PRICE Futures Group, in his daily energy report, on April 22, wrote: “Demand is busting out all over.” He explains: “Low gas prices are causing a buying frenzy at the pump as gasoline demand in the month of March hit an all-time record high.” He continues: “it’s not just gasoline demand, it is oil demand all over. Not just here in the United States but also in China. China reported that crude-oil imports in March were up a whopping 21.6% from last year coming in close to 7.7 million barrels a day. …China’s demand for imported oil is stronger than it has ever been.” He also addressed; “the strongest ever volume increase in Indian demand.”

There is growing demand.

“The market is coming in better balance,” Jason Gammel, an analyst at Jefferies, stated, according to the WSJ. “We maintain the view that the current oversupply will flip into an undersupply in the second half of the year.”

While this is good news for the oil industry, it is also good for everyone – even though it means higher prices at the pump. If this optimistic view is correct, it means the global economy – despite the bad economic news on the American front – may be heading toward a net positive; that it is not “trapped in a death spiral.”

A growing economy needs energy and that is why higher demand – that equals higher prices – is good for everyone.

The author of Energy Freedom, Marita Noon serves as the executive director for Energy Makes America Great Inc., and the companion educational organization, the Citizens’ Alliance for Responsible Energy (CARE). She hosts a weekly radio program: America’s Voice for Energy – which expands on the content of her weekly column. Follow her @EnergyRabbit.