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Oil Pricing and Trends Following OPEC Decision

December 11, 2020

OPEC's recent oil talks have been dominating headlines - how can we expect their decisions to impact pricing and trends over the next year? Catch our newest TrendsTalk episode with ITR Analyst Taylor St. Germain to learn more.

 

 

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Transcript by Rev


Thanks so much for joining me on this episode of Trends Talk. My name is Taylor St. Germain, I'm a speaker and analyst at ITR economics. I'm coming to you all from Dallas, Texas, and I felt it's only appropriate to discuss oil, especially with the most recent OPEC meeting headlining the news last week.

Let's first start off where oil is trading today. When I signed on oil... West Texas Intermediate, currently trading at $45.70 per barrel. Now let's discuss, we'll discuss if that price is likely to change, but let's first talk about the decision made by OPEC, because that's going to be at the forefront of that price conversation that we have here today.

So if we think back to April OPEC last decided that it was appropriate to cut levels of production as a result of the directional movement of prices. So, because prices were heading much lower in April, we even had that negative day back in April of this year. Many of you will remember that historic day OPEC decided to cut levels of production in order to buoy that price and likely save the industry from a steeper collapse when it comes to prices.

Now, we fast forward a few months and prices have recovered to, still not a level that all of us here in the United States are overly thrilled with, but to a level that is generally more profitable with prices trending in that $40 per barrel range. So OPEC was faced with a decision. Does OPEC and the allies continue to extend the production cuts that they implemented back in April? Or is it time for OPEC, and the non OPEC allies to increase levels of production? They face a pretty challenging scenario when weighing out these options.

First, if OPEC decides to continue to extend production cuts, then it's very likely that we do see the price of oil continue to rise, but that's good news for U.S. firms and the concern that OPEC and the non-OPEC allies have is that as that price appreciates, you'll see the United States and other countries swoop back in and take some of that market share that was lost throughout this last year.

So, the second scenario OPEC could decide to increase production levels. Now, the concern with increasing production levels is that analysts would tend to believe that the price would likely falter as a result of increasing production levels.So that's the situation that OPEC was facing going into last week was, do we extend production cuts and risk market share? Or do we increase production, maintain our market share position, but understand that's likely to culminate in a lower price, which is bad for everyone as a whole, not just the United States, but also OPEC and the other non OPEC allies.

So they faced the challenging decision Monday and Tuesday, no deal was done among OPEC and the non OPEC allies. It actually was so heated in terms of the conversation that they had to put talks on hold and they resumed again a day later. And by Thursday, we were able to understand the decision, which was that OPEC will increase production levels by 500,000 barrels per day.

Now, oil prices didn't really drop off like many would have expected. And I think one major reason for that is even though OPEC is increasing production, there's one very important factor, which is that global demand is now outpacing global supply. So with demand picking up, even though there is a concern of more oil on the market as OPEC increases those production levels, with demand outpacing supply, that's likely good news for prices at least here in the near term.

So what does all this mean for the United States in the West Texas Intermediate price? Well, we have a few factors from supply and demand standpoint going on here in the United States. The first is that we are seeing increased production levels coming out of the U.S. in terms of crude oil production. Now we're not above the pre pandemic levels, but we're not longer declining. We have essentially reversed that production trend that we experienced throughout the pandemic. The other benefit from a supply demand standpoint is if you look at the 52 week change in inventory, so notice inventory levels are coming down.

That means the supply is coming down with the man picking up. That's typically good news for prices when those trends shape up that way. Not to mention we are seeing miles traveled here in the United States, also again, not above the pre pandemic levels, but generally building momentum from the low point that we saw in the second quarter. And then our forecast for us industrial production calls for 2021 to finish a positive year over year. So from the supply demand standpoint, directionally, we are seeing the supply demand move in a way that would buoy higher oil prices as we move into 2021, which is our forecast at this point.

Now, I do want to talk about what current price means in terms of break even levels. So, there's a very interesting survey that comes from the Dallas Federal Reserve. And the survey question essentially asks in the top two areas in which your firm is active, what West Texas Intermediate oil price does your firm need to profitably drill a new well. And based on basin is how this information is recorded from the Permian to the other regions and basins here in the United States.

That number that's quoted is typically $46 per barrel to $52 per barrel. So we're still here in the United States, trending lower than what most firms believe is a profitable level to drill a new well. And I think that's very important is that we are generally seeing production levels increasing as we get closer to the mid-40 range. And certainly it will, as we move into the higher 40s, lower 50s, based on that survey question.

But where a lot of the activity is coming from is from those existing wells that are already in place here in the United States. The same type of question was asked, posed slightly differently, in that Dallas Federal Reserve survey. And the question was in the top two areas in which your firm is active, what West Texas Intermediate oil price does your firm need to cover operating expenses for an existing well, and this is much lower. This is in that, again, based on basin $23 per barrel to $36 per barrel range.

So, much lower price point in terms of existing wells versus new wells. So until we see that oil price move into that 46, 47, 48 and even low 50 range, it's very unlikely that we see a whole lot of new investment in terms of drilling new wells based on break-even points for these organizations here in the United States.

Now, again, based on supply, based on demand, it seems likely that oil prices will rise next year. And we also need to keep our eye on COVID-19. Right now, demand is outpacing supply, which again is typically good news for prices, but does that trend continue? There's an increase in cases around the world and uptake in deaths around the world. So it will be important to understand the magnitude in terms of the impact that COVID-19 also has on that supply demand curve from an oil and gas standpoint.

It seems that better days for the oil and gas economy are ahead of us. Again, higher prices, especially as it relates to oil, typically correlate well with increased levels of industrial production and those metrics that we rely on to indicate that we have a better economy in front of us. Thanks so much for joining me on this episode of Trends Talk. My name's Taylor St. Germain, and I look forward to talking to you.

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Since 1948, we have provided business leaders with economic information, insight, analysis, and strategy. ITR Economics is the oldest privately held, continuously operating economic research and consulting firm in the US. With a knowledge base that spans six decades, we have an uncommon understanding of long-term economic trends as well as best practices ahead of changing market conditions. Our reputation is built on accurate, independent, and objective analysis.