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Is an Output Cut Imminent in the Upcoming OPEC Meeting?

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The supply glut in oil market caused investors enough pain last month. WTI crude, the American benchmark, which popped above $76 a barrel and touched multi-year high in early October, plunged to $50.29 on Nov 28. Many blame sluggish demand along with the supply glut for the fall in price levels. The dampening growth in demand stemmed from the trade war between the United States and China, two of the world’s biggest economies. However, the three-month truce in the trade war, declared in the Argentina G20 meeting, has come as a major relief. Investors however still have to wait and see the impact of the positive news on the market sentiment. Also, they expect the OPEC/non-OPEC meeting, which will take place in Vienna on Dec 6, to provide some good news. The cartel, on the other hand, is facing some huge challenges as discussed below.

OPEC’s Dilemma

Saudi Arabia Needs Money:  Per International Monetary Fund, Saudi Arabia, a dominant producer of OPEC, needs $70 per barrel in 2018 to breakeven. Moreover, the economic and energy reforms yet to be implemented in Saudi Arabia require billions of dollars. In short, the kingdom needs more money. Moreover, weakening oil prices can hurt the country’s balance of payments. John Kemp of Reuters stated that the country’s foreign exchange reserves fell from $750 billion in 2014 to $500 billion presently. Additionally, the national energy company, Saudi Aramco also plans to invest $500 billion over the next 10 years to expand its international footprint. In conclusion, Saudi Arabia would not like the present oil output to continue, which weakens the crude prices.

Support from Russia: A significant non-OPEC country, Russia, was initially averse to supply cut.  However, reports suggest that Moscow has understood the dire need of slashing output. The second-largest oil producer can support OPEC in the upcoming meeting to reduce overall crude production. It is to be noted that Russia, per its Energy Ministry’s budget, requires $40 per barrel to reach balance in 2018. So, a production cut, which will most likely lead to higher prices, can boost Moscow’s budget surplus.

Other OPEC Members: Countries like Algeria, Nigeria and Libya are heavily dependent on oil exports. A huge portion of export income comes from crude supply for these countries. Hence, an output cut will have a significant negative impact on their balance of payments. Individually, these countries contribute a small portion to OPEC’s total output. However, the low prices are not doing any good to them either. Per International Monetary Fund, Algeria needs oil prices at $105.70 a barrel while Libya requires $132.80 to balance their budget in 2018. So, small countries in the cartel cannot take lower prices while a production cut can harm their budget balance.

Trump Tweets for Lower Prices: President Donald Trump has made it clear through his tweets that he wants fuel prices low, which primarily requires crude prices to be low. Moreover, his relation with Saudi Arabia can have an effect on the OPEC’s decision this week. Considering all the speculations related to the murder of journalist Jamal Khashoggi, allegedly involving Saudi Arabia, political pressure can play a settling role in their decision, as curbing production can anger President Trump, their political ally.

Advisory Committee Pushes for Cut: The advisory committee of OPEC reportedly suggested 1.3 million barrels per day output curb last week from the production levels of October. Notably, the cartel produced 32.9 million barrels of oil per day in October. It is to be seen whether the suggestion is followed by the members.

Given all these factors, a supply cut is the most likely outcome. However, the magnitude of the cut may not reflect the amount suggested. Saudi Arabia needs to implement the production curb to improve its economy. Therefore, the degree to which the country succumbs to President Trump’s pressure needs to be seen. Other OPEC countries’ interests will also play a significant role in the decision making process. Even if the supply curb does not reach the 1.3 million barrels per day mark, it might be close to it and will likely allow prices to rise again. Although prices may not reach October levels, a substantial rise is currently required in the market. Therefore, an output cut, which is the most possible outcome of the meeting is expected to bring positive news for the producers.

E&P Companies in Focus

The volatile oil exploration and production companies will be the most affected by the OPEC meeting’s outcome, as their fortunes are tied to commodity price fluctuation. Energy investors will be closely tracking S&P components including the likes of Marathon Oil Corporation (MRO - Free Report) , Hess Corporation (HES - Free Report) , Newfield Exploration Company (NFX - Free Report) and EOG Resources, Inc. (EOG - Free Report) . Each of these firms has a Zacks Rank #3 (Hold), which means that investors should preferably wait for a better entry point before buying shares.

If you are looking for a near-term energy play, Enterprise Products Partners L.P. (EPD - Free Report) may be an excellent selection. This company has a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Houston, TX-based Enterprise Products has an extensive network of pipeline that spreads over almost 50,000 miles. The partnership’s midstream properties are linked to all prospective shale plays in the United States rich in natural gas and oil. Its earnings for 2018 are expected to surge more than 36% year over year.

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