Oil and Gas

An OPEC deal to cut output could disappoint markets

Oil prices have fluctuated on comments that OPEC countries might agree to an output cut next week. However, the historic meeting might not be enough to revamp oil prices.

Libya and Nigeria aren't expected to sign the deal and the full-backing from two key countries – Iraq and Iran – is not guaranteed.

CNBC takes a look at what might happen in Austria next Wednesday.

Why is the OPEC meeting on Wednesday important?

Ryad Kramdi | AFP | Getty Images

"It's the first time since November 2014 that OPEC members meet to try to control oil prices," Colin Smith, head of oil research at Panmure, told CNBC over the phone.

Oil prices have been trading at historic lows given an oversupply in the market. Brent crude started this year trading at $35 a barrel and though they have rebounded to about $45, the oversupply is expected to remain a drag throughout 2017.

The production of shale oil in the U.S., Iran's attempt to increase oil exports, and sluggish growth in advanced economies are the main factors bringing oil prices down.

What are the chances of a deal?

President Nicolas Maduro of Venezuela said Wednesday that a deal to cut output was "imminent" and asked his oil minister to talk to Russia in an attempt to bring non-OPEC members to support he deal.

But analysts have doubts whether, and to what extent, an output cut will be agreed upon.

"We believe there is a 70 percent chance that OPEC could announce a 1 million barrel of oil per day production cut on next Wednesday, 30 November, during the cartel's formal meeting in Vienna," Nomura said in a research note.

However, research from Societe Generale is less optimistic. "Our view is that it is a 50-50 tossup, and it is not currently factored into our balances," the French bank said in a note.

Smith from Panmure told CNBC that "while reaching agreement looks tricky, it would be surprising if there was not some kind of firm commitment from Saudi and its key Gulf allies, given all the issues were clearly visible at the Algeria meeting, yet Saudi was willing to sign up to a revised OPEC target."

Reuters reported that OPEC members will debate an output cut of 1.2 million barrels a day, but Iran, Iraq and Indonesia have shown reservations to such proposal.

"There is likely to be some level of action to cut output but it may not be clear whether that will be sufficient to meet the new 32.5 – 33 million barrels a day target," Smith added.

What’s the role of Russia?

Russian President Vladimir Putin.
Mikhail Svetlov | Getty Images

Russia is not part of the OPEC group but its troubled economy would benefit from an increase in oil prices. But the solution advocated by Moscow is an output freeze and not an output cut.

The country's energy minister, Alexander Novak, said Thursday that Russia could cut down its oil production plans in 2017 if a global output freeze pact is applied, Reuters reported.

Though Russia's involvement is seen as market positive, it's unlikely that the final deal would require a formal backing by non-OPEC members, Smith explained.

What is the worst possible scenario if the OPEC doesn’t reach an agreement?

"If no OPEC agreement is reached, we would probably revise our 2017 price forecast significantly downward, because we would be left with our current neutral fundamental outlook. Without an OPEC cut, the global rebalancing will progress much more slowly than previously expected and be pushed beyond next year," Societe Generale said.

The French bank is expecting Brent to reach $52.50 in the first quarter of next year, $55.00 in the second quarter. WTI is forecast at $51.00 in the first quarter and at $53.50 the second quarter.

How will markets react?

"Trust is a one-time gift. OPEC proposed this production cut (of 1 million barrels per day) in September during the informal meeting in Algeria. Failure to ratify this production cut in Vienna could risk losing the trust of the market, triggering further oil price weakness," Nomura warned in a note.

What will happen to oil prices?

Excess gas is burnt off at a pipeline at Rumaila oilfield in Basra, Iraq.
Essam Al-Sudani | Reuters

OPEC's aim is to increase oil prices from their current historic low levels. According to Nomura, prices should go up by at least $2 per barrel of oil.

"We believe oil prices will almost certainly rise more than USD2/bbl in the weeks following this potential OPEC production cut. This means that OPEC can most likely benefit from rising revenue despite cutting production and potentially ceding some market share to US shale producers," the bank said.

Goldman Sachs is also expecting some deal next week to normalize oil prices. "We think a cut should generate backwardation – helping OPEC grow market share by sidelining higher-cost producers – and reduce oil price volatility – increasing the valuation of their debt and equity," the investment bank said in a note earlier this week.

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