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Will OPEC Finally Raise Production to Avoid Market Imbalance?

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All eyes are on the outcome of the OPEC meeting on Jun 22, which is expected to be driven by the recent developments in the oil industry. On the one hand, Saudi Arabia and Russia are advocating a rise in production, while on the other countries like Iraq, Iran and Venezuela are opposing the stance.

Notably, Saudi Arabia proposed a 1-million barrel per day (BPD) production hike prior to the meeting. Several leading producers also feel the same way. The Chairman of Permian behemoth Pioneer Natural Resources Company (PXD - Free Report) – currently carries a Zacks Rank #3 (Hold) – Scott Sheffield, recently took an unusual step and publicly urged the 14-nation consortium to produce more crude to keep the global oil supply and demand in balance. Pioneer Natural Resources carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Supply Demand Imbalance

Stable Demand: Global energy demand is on the rise primarily due to growing consumption in Asia and other economies. The trend is expected to continue till 2040 at a pace of around 1.3% per annum, said BP p.l.c. (BP - Free Report) in its latest annual outlook.  Another energy major, Exxon Mobil Corporation (XOM - Free Report) expects global energy demand to surge 25% through 2040 at a stable pace. The International Energy Agency (IEA) had also forecast a demand hike. The agency expects demand to reach 100 million BPD in 2019. It will keep rising gradually, fueled by economic growth in several countries like China, India and others.

Supply Risks:While demand is expected to rise steadily over a period of time, global crude supply is expected to take a hit due to multiple reasons, which can result in an imbalance in the energy market.

Areas of Concern

Iran Sanction: The sanctions against Iran by the United States have clouded the OPEC member’s crude export plans. Before the sanctions, Iranian crudes were transported to several European and Asian markets on a regular basis with volumes reaching as high as 2.617 million BPD. While the United States is not a buyer of Iranian oil, it exerts considerable influence on the markets. The buyers of Iranian crude and many companies with major investments in the country’s upstream sector – especially those with assets in the United States – have scaled back purchases/investments out of fear of being kept out of the world’s largest capital markets. In fact, per Bloomberg, “Shipments heading to European Union countries drop by a third” since the sanctions. Per Sheffield, 500 thousand BPD of oil were lost from the Iranian exports due to the sanctions.

Venezuela: Fast falling production in Venezuela added to the jitters. With the country tethering on the verge of an economic collapse, oil output has dwindled by almost 50% since 2005. Venezuela currently churns out less than 2 million barrels per day, much lower that its pledged level, per the OPEC-led supply cuts.

Libya: AnotherOPEC member Libya’s production dropped to 600-700 thousand BPD from more than 1 million BPD, primarily due to political unrest within the country.  The situation led the National Oil Corporation to declare force majeure on exports from two of its three ports. Companies like Repsol, S.A. (REPYY - Free Report) are having a difficult time operating in the country due to ongoing tensions.

U.S. Shale: Pipeline bottlenecks in the U.S. shale are discouraging producers, who are forced to sell their products at a discounted rate. Per Sheffield, the lack of infrastructure will lead to a flat output level in the country, especially in the Permian Basin, which has outrun other resources like Anadarko, Appalachia, Bakken, Eagle Ford, Haynesville and Niobrara in terms of production. The situation has elevated to a level, where producers in the basin are likely to stop output from wells in the coming 3-4 months, stated Bloomberg. It can force some rigs out of the Permian Basin to other resources, where growth rate is lower than Permian. Hence, U.S. shale cannot fill the blanks in supply created by the abovementioned causes.

How Will These Factors Impact OPEC’s Stance?

Sheffield thinks the U.S. shale situation, combined with OPEC related troubles can push oil prices closer to $100 per barrel, out of the producers’ comfort zone of $60-$80 per barrel, with the demand supply imbalance looming large.

However, oil touching the triple-digit mark will hurt the global energy market by impacting demand growth, affecting all producing countries – both OPEC and non-OPEC.

At the same time, increasing supply indiscriminately can push prices closer to $40 per barrel again.

Hence, OPEC’s decisions (on output) must consider these in order to maintain market stability.

Is There an Ideal Solution?

In order to achieve the desired result, the member countries need to cast their individual goals and differences aside and work toward a long-lasting solution that can keep the oil market well balanced. Therefore, top suppliers, Saudi Arabia and Russia are probably right in their efforts to step up output but just enough to compensate the reduced supply from Iran and Venezuela. In this way, oil market fundamentals will remain largely tight.

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