Big oil question: When—and if—output cuts will come

Call it a crude conundrum: global oil production is surging, demand is falling and prices are dropping fast. Brent Crude fell under $100 a barrel this week and hit a 17-month low on Thursday, and West Texas Intermediate was trading close to $90 a barrel. All of which has some traders asking when—or if—producers will cut output in order to buttress prices.

An oil drilling rig operated by Petroleos Mexicans (Pemex) off the coast of Ciudad del Carmen, Mexico.
Susana Gonzalez | Bloomberg | Getty Images
An oil drilling rig operated by Petroleos Mexicans (Pemex) off the coast of Ciudad del Carmen, Mexico.

While crude demand typically drops in the fourth quarter, traders are increasingly concerned about longer-term global growth and its overall effect on crude demand. Specifically, problems in the euro zone and signs that China is importing less crude are making the market anxious.

On Wednesday, OPEC cut its 2014 oil demand growth forecast by 50,000 barrels per day to 1.05 million barrels and trimmed its 2015 forecast by 20,000 barrels per day to 1.19 million.

While some have been expecting a production decline that may in turn support prices, there haven't been any signs of that yet. OPEC's overall output is rising as Libyan production comes back on line. In the United States, the Energy Information Administration just boosted its forecast for U.S. crude oil production in 2015 from 9.28 million to 9.53 million barrels per day.

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"This means that by the end of 2015, the U.S. could be producing nearly 10 million barrels per day of crude oil," said Andy Lipow of Lipow Oil Associates. "At this rate, the USA could be the No. 1 crude oil producer in 2016, surpassing both Saudi Arabia and Russia."

Interestingly, Saudi Arabia is one of the only major producers scaling back. OPEC's monthly report showed that in August, the country took 400,000 barrels of crude per day off the table. Experts say it's because the Saudis need Brent prices to stay above $92 a barrel in order to break even—and analysts also think the real Saudi response would be larger.

In North America, U.S. shale oil costs about $70 to $77 a barrel to produce, and oil sands crude about $89 to $96 a barrel, according to a recent Reuters survey. But no production cuts have been made.

Futures Now: Crude falls hard
Futures Now: Crude falls hard   

Anthony Grisanti, president of GRZ Energy, noted the psychological significance of oil's recent drop. "The $100 level in Brent is a psychological support, for WTI it's $92.60. Those levels are both now resistance, which is a reversal," Grisanti said.

"I think we could see WTI go to $88," he said. "I say that because there's big support between $85 and $88. But that could happen because we're hitting the fourth quarter and historically it's a time of low demand."

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When asked about concerns over supply cuts, Grisanti said he doesn't think it's likely in the U.S. "If we get to $85, you could see producers curb supply, but that would take a few months to implement and by that time you'll already see spring demand come back online again."

Lipow said OPEC is usually the first to cut production, but it's difficult for the cartel to produce less than it is because its member states need the revenue.

"If supply cuts occur, it happens in OPEC—notably Saudi Arabia and to a much lesser extent Kuwait," Lipow said. "The other members of OPEC talk about higher prices being needed, but they refuse to cut their own production because they need the money."

In the U.S., a different strategy could be implemented. Rather than cutting supply, producers might opt to slow down on investment. "Many producers are already spending far more money than they receive in cash flow, and lower prices would be a huge negative," said Lipow. "Producers would slow down investment and lay people off."

The refineries, however, actually benefit from lower oil prices, because they mean a lower cost of production. That's actually good news as well for consumers, who have seen retail gas prices fall by 25 cents in the last 11 weeks.

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But the longer-term refining strategy could shift.

"The refineries would not be [immediately] affected [by dropping oil prices] but refinery investments for expansion due to the increase in oil production would slow down," said Lipow, who noted that a large amount of investing is ongoing in the industry, and some projects could be canceled.

"Valero is investing over $500 million at its Houston and Corpus Christi refineries," he said. "Others like Marathon Refining and Delek are also investing, while Western Refining has an (ongoing) project."

By CNBC's Jackie DeAngelis