Who Loses as OPEC Raises Output?

Matthew Carr By Matthew Carr
Emerging Trends Strategist

Oil & Gas

Vienna just sparked a rally.

And it could send crude to its highest price in years.

On Friday, OPEC and its allies agreed to increase their combined output by 1 million barrels per day (bpd).

Saudi Arabia and Iran – Persian Gulf rivals – reached a compromise… one I personally didn’t think was in the cards.

The energy markets roared higher on the news…

The Energy Select Sector SPDR ETF (NYSE: XLE), SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP), SPDR S&P Oil & Gas Equipment & Services ETF (NYSE: XES) and The United States Oil ETF (NYSE: USO) all spiked as the news hit.

It’s worth noting that the U.S. Oil ETF and the Exploration & Production ETF are outperforming the broader markets this year, according to Bloomberg. This gives them even more of a boost.

Meanwhile, companies like Cheniere Energy (NYSE: LNG) rocketed to new 52-week highs following Friday’s announcement, according to Bloomberg.

The OPEC agreement sparked a 5.7% jump in U.S. crude to more than $69, according to Bloomberg Engery. And the European benchmark Brent jumped to more than $75, according to Bloomberg Energy.

Now, I believed the oil markets were oversold. So I thought a move higher was on the table after the meeting.

U.S. crude had fallen 11% from its peak, according to Bloomberg Energy. And there was a lot of anxiety percolating throughout the energy sector as international trade tensions heated up.

I was also a little surprised to see Iran – which was talking tough prior to the meeting – agree to any increase… without putting up much of a fight.

But in the end, it was a win-win for the oil markets.

Even though OPEC agreed to raise production by 1 million bpd, the reality will be slightly different.

That’s because OPEC members like Angola, Libya, Iran, Venezuela and others can’t increase production. They’re either at or above capacity, or faced with major disruptions that won’t allow them to open the spigots.

In fact, of the 14 OPEC members, only Saudi Arabia, Kuwait, the United Arab Emirates, Iraq and Qatar can raise their output. And Iraq is limited in its ability to boost production because of ongoing disputes with the Kurdish Regional Government.

So the actual increase will likely be around 770,000 bpd… which was one of the reasons the market breathed such a big sigh of relief.

We knew going into the meeting that any increase would be less than the 1.5 million bpd that Saudi Arabia and Russia had originally proposed.

Under the new agreement, Saudi Arabia will be allowed to produce above its quota. And it’ll gain as much as 1.5 million bpd in market share by siphoning it away from Venezuela and Iran.

For the White House, those are good optics: America’s enemies suffer while its allies gain.

Of course, the White House wanted oil prices to fall in the aftermath of the deal to bring down gasoline prices for summer travel season.

But that’s not likely to happen.

Over the past several months, because of an economic disaster in Venezuela as well as disruptions in Angola and Libya, OPEC’s supply has been reduced by more than 2 million bpd

 

With new U.S. sanctions being levied against Iran, OPEC’s third-largest producer is expected to see its output cut by a third by the end of this year.

And some analysts believe it could be much more than that.

The U.S. has asked Japan to completely halt imports of Iranian oil. And it’s asking Europe and other Asian countries to do the same.

For now, the market is expecting Iranian oil production to tumble between 200,000 and 300,000 bpd because of the sanctions. But if everyone were to jump on board new U.S. sanctions, as much as 1 million bpd in Iranian production would be homeless.

But let’s be honest… India has ramped up its purchases of Iranian oil. India is the second-largest importer of Iranian crude. And China, the largest buyer of Iranian oil, never stopped buying oil from the country during the last round of sanctions.

U.S. sanctions aren’t like a move by the United Nations. There is no penalty for defying them. Countries agree to join in out of solidarity.

So in the current global mood, it’s hard to imagine China, India and Turkey agreeing to significantly ratchet down their purchases of Iranian oil.

To me, that worst-case scenario of 1 million bpd of “lost” Iranian production appears a little far-fetched right now. Still, that possibility will help keep a floor under crude prices.

Despite the anxiety-fueled breather, U.S. crude is back on track to hit my $75 price target for this year. And I think we’ll soon see multiyear highs. That makes exploration and production companies quite attractive in this scenario.

U.S. crude output is surging, closing in on 11 million bpd. But that’s not weighing too heavily on the market. Global consumption is on the rise and U.S. demand is higher than 20.4 million bpd this year.

The oil bull is still alive and kicking.

Good investing,

Matthew