Why OPEC Just Cleared the Way for $60 Oil in 2017

Just a few days ago, renowned energy investor T.Boone Pickens made the claim that as a result of the historic production cut between non-OPEC and OPEC nations, oil would hit $60 (up from $53 today) not sometime in 2017, but in the next 30 days.

Is this a bold prediction? Eric Nuttall of Sprott Energy Fund (who correctly called oil’s 2016 trajectory back in January) says $60 oil can be expected by the end of Q1 2017. The reason for the bullishness from these investors falls largely on the fact OPEC and non-OPEC have formally agreed to cutting 1.8 million bpd of supply from the market. These cuts should work to draw down the 300 million barrels of excess global supply that are weighing down prices.

Of course, the market is skeptical, which is why prices are still in the low $50s. The market has a few concerns—that OPEC and non-OPEC members won’t comply, that demand is too weak, and that U.S. shale production will rush into the market and offset any impact from the cuts.

Many of these concerns are misplaced, and the market will notice this as global inventories continue to draw down. It is important to remember that even before the massive OPEC and non-OPEC deal, the oil market was rebalancing; according to a recent IEA report, global commercial crude inventories fell for the third straight month in a row in October (the last month with data). They are currently 300 million barrels above the five-year average, but down 75 million barrels from the highs set in July.

This is the definition of a market that is rebalancing, and the recent agreements will only accelerate this.

Will the OPEC and non-OPEC deals work?

It is important to note that between OPEC and non-OPEC producers, over half the world’s crude oil supply is now involved in cutting. Many are concerned countries members will cheat or that that countries exempt from the deals (like Iran, Libya, and Nigeria) will offset the cuts by growing their production.

This may have been a concern before the recent non-OPEC deal, but not anymore. OPEC originally agreed to cut 1.2 million barrels per day (most coming from Saudi Arabia and its allies, who are very motivated to cut production).

If production from Iran, Libya, and Nigeria all came online it would add 600,000 bpd according to Bank of Nova Scotia analysts, making the OPEC cut really only 600,000 bpd in total. On December 10, non-OPEC producers agreed to come in to the OPEC deal and cut nearly 600,000 bpd themselves, which basically offsets the growing supply from Nigeria, Libya, and Iran.

This means 1.2 million bpd of crude will be cut from the market. Investors should not be concerned about non-OPEC producers (like Russia) cheating, since the cuts that they agreed to would be occurring anyway.

These cuts will undersupply the market even further than currently (in other words, inventories will fall even more than they already are) and the result will be higher prices. While many worry about the higher prices leading to a big spike in U.S. shale production, oil prices of $60 or above will be required for a sustained period to see any type of large spike.

There have been 160,000 layoffs in the oil industry, and many companies are still indebted and unable to access capital, which will limit the speed of production growth.

Crescent Point is a good way to play the trend

Many oil producers have seen huge run ups in price even recently, so investors may be reluctant to jump in to the sector. The key is to buy names that are experiencing the most undervaluation compared to peers. As prices continue to rise, investors will pour into these names since they are seen as better bargains.

Investors are still upset at Crescent Point Energy Corp. (TSX:CPG)(NYSE:CPG) for issuing equity in September, and the result is that it is currently trading at one of the cheapest multiples in the sector, despite just upgrading its production guidance for 2017 and having a strong balance sheet.

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Fool contributor Adam Mancini has no position in any stocks mentioned.

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