The past two years have been brutally tough on the oil industry. Persistently weak oil prices and increasing uncertainty caused approximately 100 oil and gas producers to declare bankruptcy since the onset of the downturn. Meanwhile, most other producers cut costs to be bare bones, causing their output to drop.
However, prices seemed to bottom out in early 2016 and should be much more stable in 2017 as a result of two OPEC agreements to rebalance the market. That intervention, combined with falling costs and efficiency gains, means 2017 could be one of the best years to invest in oil stocks in quite some time.
Draining the stockpiles
At the end of November, OPEC members agreed to end their battle for market share and instead refocus their attention on supporting oil prices by agreeing to cut their combined output by 1.2 million barrels per day. A couple of weeks later, OPEC announced an agreement with 11 non-member nations who pledged to join it by reducing their production by 558,000 barrels per day for the next six months. The aim of these reductions is to start eliminating the glut of oil that has built up over the past two years due to persistent oversupply. If everything goes according to plan, these actions could drain 46% of the estimated 300 million barrel excess stockpile over the next six months. That would result in a more balanced oil market going forward, which could stabilize oil prices much higher.
While many market watchers have their doubts that OPEC will implement these agreements to the full extent, even partial compliance should help reduce the supply overhang quicker than relying on the natural decline of production due to underinvestment. That said, after two years of underinvestment, the market has gotten much closer to rebalancing on its own. According to data from oil-field service company Core Labs (NYSE:CLB), production in the U.S. has already fallen by 1.3 million barrels per day since peaking in March 2015. That decline, when combined with similar natural declines elsewhere, has global production on pace to slump 3.3% in 2016. Meanwhile, demand continues to march higher, which should lead to a much tighter oil market in 2017 even without OPEC. In fact, that outlook had Core Labs anticipating that a V-shaped recovery in the oil market was on the horizon well before OPEC stepped in to support prices.
Unless oil demand falls off a cliff, market fundamentals should be much better in 2017 than they were for most of the past year. This improvement alone should lift a weight that had been holding down oil stocks. Read full article.
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