Oil rally to roll on after combined cuts from OPEC, non-OPEC producers

Oil prices are set to rise as 11 more countries agree to cut output. Photo: Hasan Jamali The shale oil industry in the United States could undo the price hikes caused by the production cut, but it is too early to know when. Photo: Jacob Ford

Rising oil prices could rejuvenate the lagging United States shale oil industry, analysts say, a move that would add more supply and work against OPEC’s plan to cut production.

Crude oil prices are set to rise above $US60 per barrel over the coming months after 11 countries agreed to join the OPEC production cut on Sunday. The non-OPEC nations, including Russia, Malaysia and Oman, agreed to reduce output by 558,000 barrels per day two weeks after OPEC’s landmark production cut.

That move saw Brent and West Texas Intermediate, or WTI, crude jump by over 4 per cent to $US56.68 and $U53.97 on Monday.

Oil prices have surged by more than 50 per cent this year and have doubled since Brent hit a low of $US27.88 in January.

“There’s still upside to oil prices despite the rally this morning,” said ANZ senior commodities strategist Daniel Hynes. “Certainly something in the mid-60s is quite achievable over the next few months.”

Energy was the best performing sector on the ASX on Monday, gaining around 3 per cent.

Mr Hynes said the decision by the non-OPEC producers in the early hours of Sunday morning, Australian time, “certainly surprised the market”, and even “more so” Saudi Arabia’s announcement just minutes later that it may cut production to below 10 million barrels per day.

The unilateral decision from the world’s biggest crude producer marked a change of strategy for the Gulf kingdom and was evidence that it is less concerned about losing market share than in previous years, Mr Hynes said.

In June 2014, the Saudi Arabian government upped oil output in order to make American shale oil uncompetitive in response to dwindling market share.

But prices have once again crossed the break-even point for US shale oil producers, and any ramp-up in production could spoil the effect of 22 OPEC-member and non-member countries’ combined output cut.

This will eventually bring down the prices created by the cartel, but that time has yet to come, say analysts.

“The scale of cuts that have been announced over the past couple of weeks would essentially negate any increase from the US anyway and push the market into deficit,” said Mr Hynes.

He added that the potential uptick in the US shale oil industry would remain a medium-term risk, with the oil rig count already trending higher before any overseas cuts had been announced.

“It will be some time before we see the impact of that and the recent price rise,” he said.

This sentiment was echoed by UBS resources and utilities analyst Nik Burns, who said in an email: “We would need oil to be closer to $US60 per barrel to see a large uptick in drilling activity to drive production materially higher.”

“Right now our view is that the current level of shale drilling activity can hold production largely flat,” he said, noting the construction of new shale oil wells would merely offset a decline in output from existing ones.

But when US shale oil producers do return higher output levels as expected, the current price increase will be in jeopardy.

“The gravity of their return will determine where prices top out at,” said Mr Hynes. “That is a headwind that will keep some sort of upside cap on prices in the shorter term.”

However while stocks are already up, the effectiveness of the production cut remains to be seen.

OPEC members met an average of 60 per cent of their commitments across 17 production cuts since 1982, according to Goldman Sachs, with the figure rising to around 80 per cent in recent years.

To solve this problem, OPEC has formed a compliance committee for the new round of cuts comprised of member and non-member countries. #OPEC & NON-OPEC deal to cut production:

Total cut 1,722 kb/d

% of Cut Prod: KSA 28.2% Russia 17.4% OPEC 67.6% NON-OPEC 32.4%#OOTTpic.twitter苏州美甲培训/ZNydCdj3OJ— JEFAIN ALHAJRI (@JRJ_ALHAJRI) December 10, 2016

Regardless of compliance, the establishment of the agreement itself is nevertheless a positive sign, said Mr Hynes.

“There was certainly some scepticism about how non-OPEC producers would be able to come to some sort of agreement, but clearly Russia has been the driving force and has been able to bring others on board.”

The cuts include almost every major oil producer except the US, Canada, China, Brazil and Norway, and will apply to the first half of 2017.

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