For the first time since oil prices started plummeting in the summer of 2014, there’s a bit of certainty regarding where the industry is headed. Members of OPEC, the multi-nation oil cartel, has reached a tentative agreement to cut oil production in an effort to raise oil prices.
While this is bad news for commuters who need to fill up their cars regularly, this is great news for the range of oil companies that needed prices to go up in order to improve their financial situation. Future prices for crude oil in September shot up 8 percent, mostly due to the news. Shares of oil and oil-related companies also rose sharply on the news.
On paper, this tentative deal is exactly what shareholders in the oil and oil-related companies have been looking for. Oil prices are half of what they used to be since 2014. Everyone from big oil producers to America’s natural gas producers have taken a hit. The Vanguard Energy ETF (VDE), which is comprised of oil companies, is down 30 percent since the time prices started dropping.
This deal could be a boon for long-suffering oil investors, but some believe the deal might not mean much in the long term.
Why the Deal Could Be Big
The tentative agreement states that OPEC, which counts Saudi Arabia, Iraq and Iran as its biggest oil producers, will limit daily production by almost 1 million barrels, to 32.5 million barrels a day. That number isn’t enormous, but some hope it’s enough to limit further price drops and help oil stabilize at higher prices.
While the drop in production might not be as much as some investors hoped, it is a big symbolic victory. OPEC can be a stubborn beast that refuses to make agreements even when oil prices are tumbling, as 2014’s drop due to oversupply showed. This tentative agreement is the first time since 2008 that OPEC has agreed to cut production.
As the irrationality of markets shows, sometimes symbolic victories are as important as quantifiable wins.
U.S. Shale: The Other Side
The biggest losers during the drop in oil prices were American shale companies. The big oil companies were blessed with deep pockets and the means to weather a long decline in prices. These upstart American shale producers attracted the ire of OPEC.
The long decline in prices wasn’t enough to derail the American producers, as they proved more resilient than expected. Many companies managed to adapt to the low prices. However, more than 60 companies went bankrupt during this time.
If prices manage to go up, the shale producers will be in an even better position than they were during these lean years. Bloomberg estimates that U.S. oil production will be higher in 2016 than in 2014.
If oil prices do, in fact, rise, then exchange-traded funds that focus on shale and shale-related companies are poised to go up. The SPDR S&P Oil & Gas Equipment & Services ETF (XES) has risen 12 percent since the tentative deal was announced. The PowerShares S&P Small Cap Energy Portfolio (PSCE) is up nearly 10 percent on the news.
Is the Deal Enough?
The big unknown remains whether the positive effects from the deal will last for the long-term. Not everyone is optimistic that the deal will do much to raise prices of oil in the U.S. Some are doubtful the reduction in daily production will take place due to the preliminary nature of the agreement.
If prices go back down, you can expect a number of oil companies’ share prices to drop accordingly. Until then, stocks are reacting very positively to the news.