Oil Fundamental Forecast – December 1, 2016

Crude oil futures surged over 10 percent on Wednesday after major producers OPEC and Russia agreed to a deal to cut supply in an effort to drain the global supply glut. To some analysts, the price surge represents a knee-jerk reaction to the initial story. They believe that prices are likely to retreat because the production cuts represent a short-term solution to a longer-term problem.

OPEC’s decision to agree to its first cut in output since 2008 came about after Saudi Arabia decided to take a “big hit” in production while allowing its rival Iran to only freeze production, rather than reduce it. The cartel also decided to coordinated action with non-OPEC member Russia for the first time in 15 years.

The new deal would reduce output by around 1.2 million barrels per day from January 2017. That would take its output to January 2016 levels.

Forecast

Skeptics are already casting doubts on whether the new deal will actually lead to a substantial drop in supply and a subsequent rise in prices.

British bank Barclays said, “The outcome is consistent with…what OPEC production levels were expected to be in 2017 irrespective of the deal reached.” They also said, “This is an agreement to cap production levels, not export levels.”

Other analysts are saying that since the cuts will only take effect in 2017, supplies the rest of 2016 will remain ample. Because of this, the short-term rally is not expected to last since the foundation of the current rally is unstable.

Traders should also note that cuts by OPEC and Russia would leave the market open for other producers, especially U.S. shale drillers, to fill the gap.

Recent data shows that U.S. crude production has already risen by more than 3 percent this year to 8.7 million bpd, as its drillers have slashed costs in an effort to compete in a lower price environment. We expect to see U.S. producers increase the number of working rigs over the near-term in an effort to capture some of the market left open by Saudi Arabia and Russia.

The short-term range for January WTI crude oil is $52.74 to $42.95. Its retracement zone is $47.85 to $49.00. The market is current trading above this zone, giving the market an upside bias. Look for this bias to continue as long as the market remains above this zone.