Do OPEC’s Actions Signal the Start of the Long-Awaited Recovery in Crude?

OPEC production cuts won’t be enough to spark a sustained rally in crude because oil sands output from energy majors such as Suncor Energy Inc. (TSX:SU)(NYSE:SU) and Imperial Oil Limited (TSX:IMO)(NYSE:IMO) continue to grow.

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Against all odds, crude has rallied in recent days, recovering from the 12-year lows reached earlier this month. This can be attributed to a range of factors with one of the most important being rumours of potential production cuts by OPEC, but it is uncertain if this will be enough to trigger a sustained recovery.

Now what?

It isn’t just North American oil producers that are suffering from sharply weaker crude. A number of OPEC members including Venezuela and Nigeria are also feeling the pain. Those two countries and many other OPEC members are highly dependent on oil revenues to fund their budgets.

As a result of weak prices they have massive funding shortfalls, which means they are incapable of running budget deficits for prolonged periods when coupled with a lack of financial reserves.

Nigeria and Venezuela need crude to be at $120 per barrel, roughly three times higher than where it is now, in order to balance their budgets. The revenue shortfall is not only impacting their economies but also their political stability.

Even the Saudis, who have remained firmly committed to keeping the spigots open, appear as though they may change their position because of mounting financial pressures. The IMF estimates that if crude remains at current prices, Saudi Arabia will incur a budget deficit of $87 billion in 2016 and run out of currency reserves in the next five years. This is placing considerable pressure on a state that needs to fund a range of internal programs to prevent dissent, while it is also paying for a costly war in Yemen and for military strikes against the Islamic State.

Consequently, OPEC is trying to coordinate production cuts with major non-OPEC oil-producing countries such as Russia. These discussions have breathed life back into the price of crude as the markets anticipate production cuts at some stage in the foreseeable future.

This would see a modest uptick in prices that would offer some relief to beleaguered oil companies such as Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) and Pacific Exploration and Production Corp. (TSX:PRE), which are now on life support.

Nevertheless, any substantial bounce in the price of crude appears unlikely.

Even if OPEC successfully coordinates production cuts, these will more than likely be moderate and have little effect on the price of crude. This is because of the global supply overhang of two million barrels daily, which would require a massive supply cut to boost prices, and this is unlikely to happen any time soon.

You see, Iran has stated that it will boost its output by 500,000 barrels daily now that sanctions have been lifted.

Surprisingly, despite the oil crunch, crude production in Canada continues to grow. According to data from Canada’s national energy regulator, 2015 output grew by 3% compared with 2014, and the regulator estimates that it will grow by 18% in 2016.

Most of this increase will come from oil sands operations.

Despite softer oil prices, energy majors such as Suncor Energy Inc. (TSX:SU)(NYSE:SU) and Imperial Oil Limited (TSX:IMO)(NYSE:IMO) are increasing output from existing oil sands operations and pressing ahead with new projects including Fort Hills and the Kearl Expansion.

So what?

Discussions between OPEC and non-OPEC oil producers about curtailing production to boost prices may be promising, but these alone will do little to boost prices. In fact, it will take a substantial uptick in demand or a significant supply cut to eliminate the global supply glut and boost prices. This means that investors should regard energy stocks with some caution, particularly because there is no bottom in sight for crude at this time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

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