Crude Oil: ‘Do Whatever it Takes’

BARRON’S

Crude oil ETFs are rising on news of Saudi Arabia and Russia’s commitment to a 9-month extension of production cuts.

Saudi Arabia and Russia announced on Monday that they decided to extend oil production cuts by another nine months or through March 2018. Crude oil prices are rising on the news, giving energy stocks a boost.

 Illustration: Photo by Ian Forsyth/Getty Images

United States Oil (USO) and the iPath S&P GSCI Crude Oil ETN (OIL) has gained 2.7% apiece so far this morning, while the Energy Select Sector SPDR (XLE) has risen 1.37%.

To be sure, this news comes ahead of the Organization of the Petroleum Exporting Countries or OPEC‘s scheduled meeting on May 25. Though Saudi energy minister Khalid al-Falih and Russia’s Alexander Novak promised “to do whatever it takes” to reduce global inventories to their five-year historical average. Goldman Sachs’ Jeffrey Currie, in a note published today, said that the announcement will help “extend” crude’s rebound. However, Currie noted that today’s rally has been modest, because the market’s focus has shifted. He explains:

We believe that today’s announcement is consistent with OPEC’s desire to achieve both price stability and backwardation, which will help to slow the recovery in shale oil production by curtailing the market’s ability to grow future production through forward sales.

For the strategy to work, however, we believe that (1) compliance needs to remain high and (2) long-term oil prices need to remain low to prevent shale producers from ramping up investment significantly more. In fact, an extension of the cuts should go hand in hand with guidance of future production increases by low cost producers, in our view, with an already notable emphasis by Saudi and others that oil prices will likely remain in a $45-55/bbl long-term range, in line with our forecasts.

The firm is staying their $57/bbl Brent forecast for the third quarter. And of a production cut extension? “Increasingly likely,” wrote Currie.

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