Last Friday (December 6) OPEC members and several non-member allies reached an agreement to reduce oil supply by an additional 500,000 barrels per day starting in January next year. In addition, Saudi Arabia also announced that it would voluntarily reduce production by an additional 400,000 barrels per day on top of the production cuts agreed by OPEC+ members. This will be the country’s lowest production level since 2014. As soon as the news came out, international oil prices soared, hitting a three-month high of $59.85.
OPEC production cuts are a positive development for the oil market as it will help keep supply at or below demand levels. Growth in the oil market has been slowing due to international trade disputes. However, the rapid growth of U.S. oil production has caused excessive oil to accumulate in inventories. Production cuts will help consume this excess oil and further boost crude oil prices.
After OPEC officially announces its production reduction plan, oil prices may continue to rise. Reduced supplies should lead to lower global oil inventory levels, which typically push oil prices higher. Of course, this assumes that demand continues to grow as expected and that supply from outside the OPEC alliance does not grow faster than expected.
In both cases, there are reasons to be optimistic. According to reports, the international trade dispute is expected to be resolved, which will be a positive sign for the global economy and oil demand. Meanwhile, most U.S. oil companies plan to spend less on drilling new wells next year due to turmoil in the oil market. Due to these factors, oil prices could rise to $60 per barrel in the coming months.
High oil prices are good for oil companies
If oil prices really rise to $60 per barrel, Benefiting the industry as a whole, as oil companies will generate more cash flow. The biggest beneficiaries will be those companies with the lowest costs, as they can generate more cash.
US For example, US-focused oil producer Devon Energy only needs to average $48 next year to support its spending plans. At that price, it can pay dividends, fund a capital spending program and drill enough new wells to boost oil production by 7% to 9%. Therefore, if oil prices rise above this level, it will create an increasing supply of excess cash.
If crude oil prices average around $60, Devon Energy could generate $675 million in excess cash. To put this into perspective, if the money were used to repurchase shares, 8.8% of the outstanding shares would be redeemed at current prices.
If crude oil prices exceed $50 a barrel next year, several other drilling companies will be set up to generate large amounts of free cash. So if oil prices are above $60, they will return a lot of cash to shareholders through their stock buyback program. ConocoPhillips has said it will spend $3 billion on buybacks next year and will use its cash balances if necessary. Marathon, meanwhile, recently strengthened its repurchase authorization and now has $1.45 billion available.
Reassuring the oil market
Crude oil prices have been volatile this year due to conflicting supply and demand levels. However, OPEC is trying to ease supply concerns by further curbing output. This will help support crude oil prices in the coming months, which will benefit low-cost U.S. oil producers. That could help boost their share prices, especially given that most banks plan to use the funds to buy back large chunks of their outstanding shares.
BBVA Research has released its U.S. oil price outlook, highlighting expectations for further growth in oil production in 2020, albeit at a slower pace.
Oil price expectations for the year ahead are for weak demand growth in a well-supplied market, with tensions and protectionism in the Middle East being major sources of uncertainty. There are additional uncertainties about the long-run equilibrium, notably capital expenditure, protectionism, transport infrastructure, alternative energy, climate change, efficiency and technology.
The chief U.S. economist of Spanish Bank BBVA said it expects the closing price of Brent crude oil in 2019 to be between US$60 and US$65 per barrel, and the long-term equilibrium price will be About $60 per barrel. Slowing refining activity and lower margins are also putting downward pressure on crude oil demand, while inventories are trending closer to the five-year average.
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