Will OPEC deal send oil crashing to $30?

The Motley Fool
Oil well, nodding donkey
Oil well, nodding donkey

The OPEC deal is done and oil traders are celebrating. Or at least they were yesterday when the oil price jumped 8% and briefly topped $52 a barrel. Oil explorers did even better, with Premier Oil and Tullow Oil up around 18% and 13%. Majors BP and Royal Dutch Shell rose around 4%. The large oil exporters all saw their currencies jump. The oil play was back, it seemed.


Arabian nightmare

So why am I talking about oil hitting $30 instead of $60, $70, $80? After all, the agreement exceeded expectations. OPEC has shown it still has teeth. Its 14 members will reduce output by about 1.2m barrels per day (bpd) by January. The first production cut for eight years even extends to non-member Russia, which also agreed to make unprecedented supply cuts. This will help drain the oil glut, bring supply back in line with demand, and should drive the price higher.

But even as OPEC president Mohammed bin Saleh al-Sada hailed this "courageous" deal the sceptics were beginning to pick holes in it, noting that it's "subject to non-OPEC production reductions." The agreement isn't binding, so what happens if other major producers don't deliver? This scepticism has spread to markets, with the FTSE 100 down today and WTI crude back at $49 (of course, some of this may be down to profit taking).

January chills

The cuts aren't as big as they seem either. Saudi's 486,000 bpd cut was biggest of all but that shrinks its total production to 10.058m bpd, only slightly under the 10.25m it produced in January. Iran will actually lift its total output to 3.8m bpd, some 1m bpd higher than in January. Subtracting OPEC's total 1.2m bpd cut from October's base line output brings it spookily close to January's 32.6m bpd. In January, if you recall, oil plunged to just $27 a barrel.

And the US and Canada aren't bound by any cuts and are hungry to pick up any slack. The Saudi strategy tested the endurance of shale drillers and found it remarkably resilient. Parts of North Dakota's Bakken field are profitable at $30 a barrel (although elsewhere it's as high as $67), as are DeWitt, Midland, Martin and Reeves in Texas. In the Delaware Basin, the figure can be as low as $37 a barrel. $50 oil? Bring it on.

Shale and hearty

The downturn has made US shale drillers leaner and meaner, with cost-cutting and productivity improvements lowering break-even profit levels all the time. Many will take advantage of a short-term oil price surge to hedge future production. President-elect Trump's victory is set to slash regulations and encourage new US energy industry development, boosting output.

At the same time, the shift to more fuel-efficient cars and electric vehicles will continue. Where once we talked of peak oil, now we talk of peak demand. This may not be enough to send oil crashing to $30 a barrel again (although it might if China's bubble bursts) but it could struggle to climb anywhere near $60, as many analysts were excitedly predicting on Wednesday. Yesterday's oil stock surge may already have run out of gas.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.