OPEC output cut may offer positives for oil market

Ivy Energy Fund

The Organization of Petroleum Exporting Countries (OPEC) on Dec. 7, 2018, announced it would cut crude oil production by 1.2 million barrels per day (bpd), with 800,000 from OPEC members and 400,000 from non-OPEC partners. The reduction will take effect Jan. 1, 2019, and will be reevaluated at the end of April 2019, which also is when the Iran export exemptions expire.

Equatorial Guinea
Saudi Arabia
United Arab Emirates

OPEC’s decision on a production cut was a slightly better outcome than the market had expected from this meeting and crude oil prices rose about 5% on the news.

OPEC has not released a breakdown by country of the 800,000 bpd reduction by member states. However, we think the bulk of the cut is likely to come from Saudi Arabia. Russia is expected to represent at least half of the 400,000 bpd reduction from non-OPEC partners. Iran, Venezuela and Libya are exempt from the agreement and are not required to cut their oil output.

By being vague with the details, OPEC has allowed some flexibility in how the production cuts will be executed.

For instance, if Iran oil exports continue to fall because of the sanctions imposed by the U.S. or Venezuela continues its downward spiral in output, those reductions theoretically could be included in the total 800,000 bpd cut.

It also is not clear which countries in addition to Russia will be included in the non-OPEC reduction of 400,000 bpd. Canada recently announced that it would implement a mandatory reduction in oil production because of pipeline constraints. OPEC did not specify whether this action was included in the non- OPEC total.

Ivy View: A Positive Step

The bottom line for us is that OPEC has taken a positive step toward rebalancing the world oil market and we think the move will be supportive for prices.

We would note, however, that the unknown aspects of the announcement still could nudge the market toward a more bullish or bearish outcome. In addition, effective implementation of the production cuts will be a key factor in determining how sustainable any potential oil price rally may be.

Oil prices have taken a winding path during volatile market year
Chart Showing Oil prices have taken a winding path during volatile market year
Chart Showing The Oil prices have taken a winding path during volatile market year

We think OPEC’s decision also gives U.S. exploration & production companies (E&Ps) the “all-clear” to continue maximizing oil production and taking market share, providing they have the cash flow.

We believe there will be less of a reduction in U.S. spending activity than is factored into stock prices and there even may be a slight increase in 2019. In our view, this is likely to be positive for U.S. E&Ps, oil services and refining companies.

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