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The OPEC deal-driven excitement felt at the end of 2016 has given way to a more timid 2017. While there has been a strong bounce in the rig count in core areas like the Permian and Scoop/Stack, unknowns continue to plague the oil market, making investment decisions more difficult than they were a few weeks ago.
Structurally, a return to a rebalanced oil market represents the most likely outcome. Even without 100% compliance to the proposed cuts by OPEC, Stratas Advisors assumes demand outstripping supply, supporting a rise in prices that will be muted by stubbornly high inventories. The chart below reflects the market in a world where OPEC and Non-OPEC producers hit 60% of their expected production cut target of 1.2 million barrels per day (MMbbl/d) and 600 MMbbl/d, respectively. At press time, official data estimates for January 2017 OPEC production had not been published.
But this most likely trend will face a significant number of headwinds that will take time to materialize. Here are some of the key issues that our analysts are watching.
OPEC compliance
History has taught the oil market that OPEC has a tendency to underperform their targets. While core OPEC nations like Saudi Arabia are likely to have strong compliance, OPEC nations like Venezuela, Iraq and Ecuador are less likely to comply. Additionally, countries like Libya and Nigeria—who are excluded from the deal—could see a rapid return of production in 2017 if their security situations improve. Stratas Advisors’ modeling indicates an $8 difference in Brent prices between the 100% compliance and no cut scenarios by mid-2018.
Shifting economics of shale
With rigs roaring back at the beginning of this year, service sector costs are rising. Stratas analysts estimate that a 15% to 20% increase in service sector costs is likely to lead to a $7 to $10 increase in breakeven oil prices for even some of the most productive wells in the Permian Basin. While expectations remain that the service sector will continue to compete aggressively on price, the ability for larger service providers to maintain bargaining power in key producing regions could allow for a stronger than expected price increase.
Trump administration
The election of President Trump saw a substantial bump in equities pricing for names in all parts of the oil and gas value chain, while the appointment of cabinet members like Rex Tillerson represents the likelihood of a more energy-friendly administration. Questions remain, however, around how his policy proposals will materialize and what direct impacts they may have on the market. While the approval of the Keystone XL/Dakota Access pipelines, opening up federal lands for drilling and a proposed rollback of Obama-era climate regulations are all bullish signs for oil and gas supply, proposed border adjustments for imported goods, shifts in tax policy and the future of the Iranian nuclear deal are likely to contribute to volatility over the next 12 months
The dollar and the global economy
Due to a number of strong leading economic indicators (like the 20,000 Dow Jones Industrial Average) combined with the election of Donald Trump, economic confidence in the United States is rising. But recent data released indicates that the U.S. economy is growing at a slower rate than initially anticipated, while concerns around economic slowdowns in emerging markets, terrorism in Europe and protectionist policy proposals in the U.S. are all driving hesitancy on the part of Stratas analysts. These elements could have substantial impacts on oil demand in the short run and create a more bearish pattern for market rebalancing in 2017.
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