Will OPEC's Cut Fuel American Oil?

Chesapeake Energy worker, shale oil natural gas FBN

The Organization of Petroleum Exporting Countries (OPEC) surprised skeptical traders with a deal Wednesday to cut the oil cartel’s production by 1.2 million barrels a day. Though oil and gasoline prices will climb in the short run, OPEC’s move may actually spur American drillers to action.

Two years ago, when a global oversupply sent oil prices into a downward spiral, OPEC opted to keep its wells flowing to compete with the rapid growth of U.S. production. The oil cartel was unsuccessful in its attempts to cobble together a broad freeze until a meeting in Vienna this week. Saudi Arabia, the largest OPEC producer, will bear the brunt of the cuts, as the 14 oil-producing nations attempt to slow down after a record pace of 33.6 billion barrels a day in October.

Russia, a non-OPEC producer, also agreed to participate in the effort, contributing a cut of 300,000 barrels a day.

The overall cut of 1.2 million barrels a day reflects about 1% of global oil production, further reducing the glut that has kept a lid on prices. U.S. oil futures jumped $4.21, or 9.3%, to $49.44 a barrel, the largest daily percentage gain in nine months. Shares of Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and other energy giants also climbed.

However, analysts expect the OPEC-inspired rally will cool off over time. With the value of crude approaching $50 a barrel, U.S. rigs that were idled during the two-year slump can quickly come back online.

“We are surprised by the move, having previously thought that anything short of full participation would kill a deal [among OPEC members],” CFRA Research analyst Stewart Glickman wrote in a note to clients. “The focus now shifts to U.S. producers, which we think will try to fill the gap.”

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U.S. oil drillers will be ready to capitalize on stronger oil prices. The combination of hydraulic fracturing—known as fracking—and horizontal drilling that sparked the shale boom is an expensive process. Higher prices make it more economical to increase drilling. Also, cost efficiencies established during the oil downturn have lowered the breakeven threshold for shale producers.

Goldman Sachs (NYSE:GS) forecasted that Brent crude would peak at $55 a barrel in the first half of 2017, citing the enduring impact of U.S. shale oil on global supplies. Brent crude, the international benchmark, was trading 8.8% higher at $50.45 a barrel after OPEC’s announcement, and the group is said to be targeting prices of $55 to $60 a barrel.

Tony Starkey, manager of energy analysis at Platts Analytics, said the OPEC cuts should bring supply and demand closer into balance in 2017, thus allowing oil prices to rebound next year. Over the long term, America’s oilfields could determine the market’s direction.

“Even before this agreement, expectations for U.S. production [have] been increasing throughout the year,” Starkey wrote. “Given the presumed increase in prices that the proposed cuts will provide, we can assume that those forecasts for U.S. production will likely continue to rise in the months ahead.”