Insights

OPEC Expectations

11/17/2014

Spot oil prices declined another 3.5% last week, dipping to a fresh four-year low of $73.25 before recovering in late Friday trading to close at $75.82. For the year, West Texas Intermediate (WTI) crude (Figure 1) has fallen 23% and Brent crude 28%. The majority of those declines have been recorded in the second half of 2014, as WTI traded above $100 into late July.

Figure 1: Spot WTI Prices 2014
Figure 1: Spot WTI Prices 2014
Source: Bloomberg

Oil speculators now await one of the most critical OPEC meetings in many years on November 27 in Vienna. The continued existence of the multi-decade oil cartel could be decided at this meeting. Some are speculating that OPEC will dissolve largely as a result of the shale boom in the U.S. and the roughly 9 million barrels of oil per day being produced domestically.

Until recently, I had expected the oil cartel to defend itself with a Saudi-driven strategy focused on preserving market share, not by defending price through supply output. However, I now have a higher degree of confidence that recent events will motivate OPEC to cut oil production by at least 500,000 barrels per day to as much as 1 million barrels per day at the Vienna meeting. Keep in mind, consensus expectations are not for such a significant cut. If OPEC fails to cut production, the near-term WTI price is vulnerable to a decline toward $68.

I suspect OPEC can no longer ignore recent events, beginning with the recent Republican election victories in the Senate and House. Friday’s Keystone XL pipeline “yes” vote only intensifies the domestic energy conversation. I expect mainstream news headlines will soon be filled with the Republicans aggressively pushing to lift the ban on crude oil exports. The tone regarding U.S. domestic energy policies has changed markedly in the past few weeks, and OPEC must acknowledge and respond to that in order to stay relevant.

In addition, China’s economic growth has continued to soften, which will further weaken its oil demand.  From mid-2013 to the present, China’s year-on year-oil consumption is trending lower. The International Energy Agency estimates that 29.2 million barrels of oil per day will be needed from OPEC in 2015. Currently, OPEC, including Iraq, produces 30.6 million per day (Figure 2). Despite reports that $75-a-barrel WTI is decimating domestic shale projects, shale production in the U.S. is expected to increase by 1 million barrels per day in 2015.

Based on mounting pressures, OPEC must cut production on November 27 or face sub-$70 WTI prices and a rather bleak future as a cartel.

Figure 2: OPEC Production, November 2008 to November 2014
Figure 2: OPEC Production, November 2008 to November 2014
Source: Bloomberg

Past performance is not a guarantee of future results.

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