Have oil prices bottomed out?

Credit: greig davidson

Oil and gas companies popped at the open today, after the Organisation of Petroleum Exporting Countries (OPEC) made a landmark decision to cut production. On the strength of this news alone, Woodside Petroleum Limited (ASX: WPL) and BHP Billiton Limited (ASX: BHP) shares leapt, rising 5% and 3% in a matter of minutes after trade commenced.

Oil Search Limited (ASX: OSH) leapt 6%, while Origin Energy Ltd (ASX: ORG), Santos Ltd (ASX: STO), and Beach Energy Ltd (ASX: BPT) each leapt more than 9% on news that OPEC would cut production from 33.4 million barrels per day, to between 32.5 million and 33 million barrels per day.

While exciting news for oil investors, I believe buyers today are likely to be burned by this announcement, for a number of reasons:

  • The cut equates to around 0.9% of total global oil supply, barely significant
  • Production limits have been imposed by OPEC before, but countries routinely exceed them
  • There’s significant idled capacity in the US and elsewhere, waiting for higher prices in order to resume production
  • The timing is also suspicious given the intended public listing of Saudi Aramco, Saudi Arabia’s oil company, which understandably benefits significantly from higher oil prices

Those who have followed the Australian oil companies over the past couple of years will know that management have said many times that drilling and exploration activities will resume when prices improve. Although higher prices will be a much-needed breath of fresh air for heavily indebted Santos and Origin, on the whole it’s tough to argue that a 0.9% reduction in supply will result in a significant, sustained increase in oil prices. In fact more than half of the world’s oil production comes from outside of OPEC, limiting that group’s ability to control prices entirely.

As to whether oil is headed back to US$100/barrel, in the short term I consider that very unlikely indeed.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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