Very quietly, the price of a barrel of oil has surged over the past year, nearly doubling, as OPEC’s plan to pressure U.S. suppliers and spur global demand begins to pay off. And this is ahead of the OPEC led plan to cut production 1.8 million barrels per day to push prices higher.
Oil prices of $100 per barrel may not be on the horizon quite yet, but it’s clear that OPEC’s strategy to regain control of oil markets is working and it may be preparing to start squeezing billions more dollars out of U.S. consumers.
OPEC’s gamble is paying off
In 2014, OPEC threw oil markets into turmoil when it decided not to cut production to support prices above $100 per barrel. The working assumption for years had been that OPEC would just cut back a little to maintain prices, but OPEC saw that as giving up market share and future control of oil markets.
It was good for OPEC when oil prices were $100 per barrel, but between 2005 and 2014 oil markets had changed. High prices had driven consumers to smaller, more fuel efficient vehicles, and U.S. production had surged because of improvement in shale technology. You can see both in the chart below.
By refusing to reduce supply, and actually increasing production over the next two years, OPEC would attempt to undercut U.S. supplies (giving OPEC more market share) and spur drivers to drive more and buy less efficient vehicles. You can see below that both trends have turned in OPEC’s favor.
Now that U.S. oil producers have cut back on investments in drilling and consumption is up, OPEC can start to squeeze markets in an effort to increase oil prices.
OPEC’s big move in 2016
The trends above show that OPEC’s strategy to regain market share and control is working. And now that trends are in OPEC’s favor, the cartel made an agreement, along with a few additional countries, to cut production by 1.8 million barrels per day.
Saudi Arabia cut its production to under 10 million barrels per day in early 2017, below what’s been set forth in OPEC’s broad agreement to cut production. So, for now, the cartel looks to be sticking to its plans to squeeze oil markets and push prices higher.
What’s not yet clear is where oil prices will finally stabilize. OPEC learned the hard way that at $100 per barrel U.S. drillers will add supply so rapidly that markets will be oversupplied. It wouldn’t be surprising to see oil settle between $60 and $80 per barrel.
Companies that will cash in on higher oil prices
If oil prices do rise, we can expect a lot of energy companies to be beneficiaries. One that should see a broad recovery is Baker Hughes (NYSE:BHI), the oilfield services company that’s joining forces with General Electric’s (NYSE:GE) energy business. As drilling increases in shale plays and offshore the companies will provide the services explorers need, giving them upside in oil without direct exposure to the commodity itself.
If prices rise far enough, we could see a big recovery in offshore drilling stocks as well. Seadrill (NYSE:SDRL) and Transocean (NYSE:RIG) are two of the biggest offshore rig owners and have been hammered by a lack of demand from low oil prices. But even a recovery to $70 or $80 per barrel could bring a surge in offshore rig demand. Both companies are still high risk, but if the supply and demand dynamic I laid out above means higher prices, both companies should benefit.
The companies that provide equipment and services to oil explorers will ride a broad wave of higher oil prices that already appears to be on the way without the risk of a single field or well’s production. And that’s why Baker Hughes, Seadrill, and Transocean are a great way to ride oil higher as OPEC takes control of the market.
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