Success of OPEC deal still in doubt

In the past fortnight (from December 15 to 29, 2016), WTI and Brent oil prices gained around 4 per cent and 6 per cent, respectively, while on the MCX, oil prices rose by around 5.2 per cent in the same time frame. The past fortnight saw oil prices gain by a good margin on account of anticipation of oil output cut by the OPEC nations. The group would take a cut of around 1.8 mbpd starting January 2017 while Russia, the non-OPEC producer, agreed for a cut of around 600,000 barrels a day. Historically, however, when the Organisation of the Petroleum Exporting Countries (OPEC) has initiated a cut, some of its members seemingly have not adhered to it. 

The positive sentiments in the oil market has been the result of optimism in the US wherein the GDP growth rose by around 3.5 per cent in the third quarter while the US consumer confidence index climbed to 113.7 in December from 109.4 in November and the highest since it reached 114 in August 2001. In the US, crude inventories remained a cause of concern, as oil storage increased for most part of 2016. Calendar year 2016 started the absolute inventory at around 451 million barrels and the current inventory as on December 23 stood at 486 million barrels, marking an increase of around 35 million barrels. 

On the other hand, investment activity in the oil sector increased recently after a recovery in crude oil prices. There are two significant merger and acquisition exercises following Royal Dutch Shell’s $54 billion acquisition of BG Group in February, which pointed to a turnaround for oil majors.  Also, On December 16, BP announced signing of agreements with Kosmos Energy to acquire a 62 per cent working interest, including operatorship, of Kosmos’ exploration blocks in Mauritania and a 32.49 per cent effective working interest in Kosmos’ Senegal exploration blocks. 

The way forward 

Right after the OPEC deal, US shale oil companies used this as an opportunity to hedge oil price risk between 2017 and 2019 at above $50 a barrel. This means producers are looking to lock in future cash flows and sales prices at above $50. This also implies that the $50 level will be a buffer for oil prices going forward. Crude oil delivered returns of around 50 per cent during the year and it is likely ti be even better in 2017 with returns of around 30 per cent as the OPEC nations pledge to cut the oil output. The US economy gaining momentum is again a good sign for oil prices. Besides, the easy money policy of the ECB will help crude oil gain further ground. In the next fortnight, we see oil prices (CMP; $54 a barrel) trading higher towards the $57 mark, while on MCX (CMP; Rs 3,677 a barrel), oil prices will move towards Rs 3,850 a barrel. 

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