OPEC's proposed production cut is looking less like it'll come to fruition with each week, and the markets are quickly losing faith that it'll actually happen.
In this clip from Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman explain why so many individual players in the cartel aren't playing nice with each other, why relatively small cuts keep being hotly contested, and some takeaways for investors who are thinking about buying into the sector in this climate.
A full transcript follows the video.
This podcast was recorded on Nov. 1, 2016.
Sean O'Reilly: Before we get into the big news of the week that involves a $30 billion check, we ought to talk about OPEC shenanigans really quick, because that's what we've been known for the past month. Why are the OPEC kiddies being mean now?
Taylor Muckerman: Well, they met last week to try and drum up an idea of what they wanted to agree upon on Nov. 30. All over the weekend, people were talking, "Oh, yeah, they reached an agreement." But then, it comes out that Iran, Iraq, Libya, Nigeria, they're still on the fence about it because they want to continue to raise production since they've either been under sanctions or had civil strife going on, so they haven't really been producing what they think they can. So, all four of those countries seem to be in agreement that they might not want to be on the hook for a production cut, leaving the other nations to take the full brunt of the supposed cut. The markets don't really think it's going to happen.
O'Reilly: They were suspicious from the beginning, even a month ago.
Muckerman: Yeah. I mean, this has happened before, quite recently, where OPEC said, "We're going to negotiate a cut," and nothing happens. We're in the same boat again, waffling, continued waffling. You look at a bunch of investment banks out there, and they're saying that they would not at all be surprised if this doesn't go through and then oil could crash back down to about $40 a barrel.
O'Reilly: On the other hand, I have noticed -- you remember two weeks ago, Russia was like, "We're totally in on a cut," and the market loved it, and oil went up. Then, this past week, Russia is like, "Eh, we don't know... " Is it possible that a lot of this is just a negotiation tactic? It's a poker game, and they're all at the table.
Muckerman: Yeah, no one wants to show their hand. These are countries, that were talking about, that rely very, very, very, very heavily on oil and natural gas sales to support their government, to support their people. It's not exactly just a few companies going bankrupt. You're talking about countries could go bankrupt if they don't support oil prices, or support their own internal production and exportation. So, yeah, this cartel has many more perspectives than just the sole cartel.
O'Reilly: Cartels encourage cheating. That's the beauty of a good old-fashioned cartel. However, on the other hand, I just never understood why these guys don't seem to care about what you learn in Econ 101, about cost benefit. Like, you decrease production by 4%, and do you make double the money on the other 96%. What is the problem here?
Muckerman: Well, that all depends on who else is producing. They thought they were going to shut U.S. shale down by collapsing oil prices. Shocker --
O'Reilly: We have technology.
Muckerman: There were some bankruptcies, but nothing uber-meaningful. In fact, the companies that declared bankruptcy are just about producing the same amount, if not more, than they were while --
O'Reilly: They keep on operating, chapter 11, or they sell their assets, run something stronger, yeah.
Muckerman: Yeah, exactly. Just because they declare bankruptcy doesn't mean they're not producing oil. So, as the prices continue to creep back up, it's much more likely that they will emerge from bankruptcy still producing oil. So, yeah, you look, in a vacuum, sure, they should cut production because they're producing at record levels. But if they do cut production, somebody's going to fill that spot, just like they did in 2014 when Saudi Arabia was like, "Yeah, we're just going to start pumping just to pump because we can." You look at all these wells that are drilled and uncompleted in the United States, nearly 4,000, those are starting to come back online. Inventory is out there.
O'Reilly: Lots of fun. And we'll know more in a week, I'm sure.
Muckerman: Yeah. You'll continue to hear more about it for the next month. Personally, I think that if you invest in oil right now, you have a little bit more downside than you do upside at the moment because if they announce it and they say, "Yeah, we're going to announce this cut," they're producing at record levels, they're not really cutting a whole heck of a lot, and that gap can be filled. If they don't say they're going to cut, then you still have this outstanding supply, and you have the downside risk.