OPEC meeting -the most anticipated event the oil market is waiting for right now- is only a few days away. The meeting outcomes will play a huge role in setting the direction of oil prices in the short to medium-term. No one knows what OPEC will agree upon in its meeting, however we do know what are the options available for OPEC. In this article we will look at three available options OPEC has and the consequences of these options.
Option 1: OPEC Agrees to Cut Oil Output
This option is what many oil market players are waiting for. Whether these players are non-OPEC producers, investors and traders or even many of OPEC producers, everyone is eagerly waiting for OPEC to come to an agreement to cut oil output in order to allow for a faster recovery of the oil market. But, to cut oil output and allow oil prices to rise to levels around $60/bbl is not an easy decision for OPEC to make. The issue boils down to the aftermath of the decision if OPEC’s members were to agree to cut oil output.
What Could Happen If OPEC Decided to Cut Oil Output?
- If OPEC agrees to cut oil output during their meeting next week, oil prices could reach to levels above $55/bbl. And by the time the actual output cut takes place somewhere in January 2017, oil prices could reach to levels above $60/bbl.
- Following OPEC agreement to cut oil output, the oil market will seem to be heading toward a recovery in a faster pace as a result of the positive impact of OPEC production cut. Oil producers will start making more money as oil prices increase and this will encourage many oil producers to increase their oil output. However, since OPEC and probably Russia would be the ones who agreed to cut and freeze their oil output, the increase in oil production will come from other non-OPEC producers such as shale oil and north sea oil producers.
- Higher oil prices will encourage many non-OPEC producers to ramp up their drilling activities and increase their oil output. When that happens, OPEC will realize that the deal was not in its favor. In fact, OPEC oil deal will limit OPEC’s members from increasing their oil output, yet other producers will still be able to increase their oil output.
- If oil output from non-OPEC producers rises, OPEC members in particular Saudi Arabia will start losing market-share which could force them to break the agreement and ramp up oil output. Not only that, but the rise in oil output from non-OPEC producers will slow down the supply and demand balance and could create another glut in the oil market. This could lead to another downturn in oil prices.
Option 2: OPEC Meeting Reaches No Agreement to Cut Oil Output
Reaching no agreement to cut oil output during OPEC meeting next week is also another possibility, but it seems that it is highly unlikely that OPEC will go for this option as it could lead to a sharp fall in oil prices which will be translated into a decline in OPEC’s members oil revenue. And this is the last thing OPEC’s members want to see right now as they are struggling financially.
What Will Happen If OPEC Couldn’t Agree to Cut Oil Output?
- If OPEC could not reach an agreement to cut its oil output in its meeting next week, oil prices could fall sharply below $40/bbl.
- OPEC could also lose whatever is left of its credibility in the oil market and it will be extremely difficult for the oil market to trust OPEC again.
- The increase in U.S. crude oil production and rig count will slow down and will eventually reverse a course as ramping up oil output and drilling for oil will not be justified economically at oil prices below $40/bbl.
Option 3: Delay and Offer More Hopes
This option is not what many in the oil market are expecting, however it could definitely be the main outcome of OPEC meeting next week. If OPEC is not yet ready to agree to cut oil output whether due to internal issues or due to the fact that few of OPEC’s members don’t want to allow shale oil producers to increase their oil output, then OPEC could continue its emotion game to support oil prices and buy more time by giving hopes and promises of production cut.
If OPEC’s members were to consider this option, they will have to come up with a strong reason to support it. They could say that an output cut deal will not be successful if not participated by major OPEC and non-OPEC producers. Therefore they need two more months to try to bring as many non-OPEC producers as possible on-board to participate in the oil output deal.
What Will Happen If OPEC Offers A New Hope Rather Than Action?
- If supported by a strong reason and new promises were made, oil prices could fall slightly and remain somewhere around $40/bbl for sometime.
- The pressure of the fall in oil prices will make non-OPEC producers discouraged to increase their oil output. This will help in restoring the balance in supply and demand.
- Oil producers will come to realize that they all have to work together in order to help the oil market recover.
The bottom-line is, OPEC is facing a delicate situation. It can reach an agreement to cut its oil output, but that makes its rivals at an advantage of benefiting from the rise in oil prices and capturing more market share by increasing their oil output freely.
It can also reach no agreement to cut oil output and continue to allow the oil market to balance itself, but that will also cost OPEC a lot in terms of losing its credibility as a strong player in the oil market and will lead to a decline in oil revenues to the already struggling oil-revenue dependent states.
This leaves OPEC with only one option; to continue to buy time by giving more promises hoping that the market will balance itself. We will not have to wait for long, it is only a few days left to know what OPEC will choose. Stay clam and watch OPEC meeting.
