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Quarter-End Insights

Energy: Despite OPEC Cuts, a Crude Awakening Is Near at Hand

OPEC output cut extensions don't appear to be enough to balance the oil market.

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  • OPEC and certain other countries agreed to extend their production cuts, originally set to expire at the end of June, by nine months (ending March 2018). There was no change to the magnitude of the production cuts of 1.8 million barrels per day, including 0.6 mmb/d from non-OPEC nations such as Russia, Mexico, and Kazakhstan.
  • The cartel might pay a steep price for any near-term benefit. We believe it is underestimating the ability of shale producers in the United States to rapidly increase volumes in a $50-$55/barrel environment (West Texas Intermediate). After several upward revisions, the International Energy Agency currently expects U.S. crude production to end the year 0.8 mmb/d higher than year-end 2016; that looks conservative to us, as we forecast 1 mmb/d. As such, the rapid U.S. shale growth in the back half of the year will meaningfully increase U.S. oil supply.
  • Once the OPEC cuts are lifted, full OPEC production coupled with rapidly growing U.S. output is likely to outstrip near-term demand growth and could easily tip the industry back into oversupply in 2018. Therefore, we are not changing estimates after this first look at the new OPEC agreement. Our 2018 and midcycle forecasts for WTI are still $45/bbl and $55/bbl, respectively.
  • Energy sector valuations look fairly valued at current levels with an average price/fair value estimate of 0.96.

Joe Gemino does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.