The potential reduction won't have a meaningful sustainable impact on oil prices.
By Allen Good, CFA | 09-29-16 | 06:42 AM | Email Article

In a somewhat surprising development, OPEC members have tentatively agreed to a production target of between 32.5 million and 33.3 million barrels per day, representing a reduction of up to 700 mb/d from current production levels of 33.2 mmb/d. Oil prices rallied on the news, but our view for continued low prices of $50/bbl in 2017 (detailed in our Aug. 26 report) remains unchanged, as we do not believe the potential reduction will have a meaningful sustainable impact on oil prices. While the low end of the target range is nearly 1 mmbd lower than our 2017 forecast for OPEC production, and if realized, it would balance markets and reduce inventories sooner than our original expectations, we see numerous risk factors that we think prevent a sustained recovery in prices until 2018.

Allen Good, CFA, is an energy strategist for Morningstar.

First, no agreement has formally been reached, with details to be agreed upon at the November meeting. Even though the low end of the target range only marks a retreat to first-quarter levels, apportioning the production cuts could prove problematic, given the pre-existing political tensions, namely between Iran and Saudi Arabia, which could ultimately scuttle a deal or delay implementation. Second, OPEC has a poor track record of coordinating production cuts among its members, with quotas often breached or outright ignored. There are also indications that any deal might exclude Libya or Nigeria, where disruptions have already reduced production and a return of volumes would offset the proposed cuts. It’s also unclear how long any agreement would remain in place, potentially setting the stage for resumption of growth in 2018.

The biggest risk factor, however, remains the potency of U.S. shale. We expect any OPEC production cut and subsequent price response to be met with an acceleration of U.S. activity.

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