The price of WTI and Brent crude fell despite another production cut from the Organization of the Petroleum Exporting Countries (OPEC). The cut was expected and helps keep the oil market in a tight balance, so this looks like a buy-the-rumor-sell-the-news event. Ultimately, OPEC has created confusion in an otherwise hard-to-forecast market, but the odds are high that oil prices will rise again and soon.
OPEC’s latest policy is to curb production by 2.2 million barrels per day starting in Q1 2024, including the voluntary cuts by Saudi Arabia and Russia, leaving the net increase at 0.9 mbpd. Because compliance is voluntary, analysts are unconvinced the move is sufficient to support oil prices despite OPEC's 40%+ market share.
Coincidentally, the 0.9 million barrel per day cut aligns with the EIA’s latest forecast for supply. The EIA's early November forecast is for global supply to increase by about one mbpd in 2024 to keep supply slightly ahead of demand growth. Now, it looks like the market is more evenly balanced, which leaves economic activity, inflation and interest rates in the driver's seat unless the EIA is wrong. OPEC forecasts demand to grow more than two mbpd, which could happen given the outlook for interest rate cuts next year.
Inflation cools: FOMC on track to cut rates
The Federal Open Market Committee (FOMC) has yet to come out and indicate the first interest rate cut or even call a top to the cycle, but the market is pricing it in. The October read of the PCE Price Index confirms that inflation is cooling at the expected pace, raising hopes for a soft landing.
As it is, the CME’s FedWatch Tool shows a 0% chance for another rate hike, and the first appreciable chance for a cut is in March. The odds rise to nearly 80% for a cut in May and will likely increase given the trajectory for inflation. In this scenario, interest rate cuts will help to unstick the housing market and general economic activity, spurring oil demand.
The risk is that inflation will begin to cool faster than expected, which could lead to disinflation, deflation and economic stagnation if not an outright recession. In this scenario, no FOMC rate cuts will help support oil prices.
Energy companies sitting pretty with higher prices forecast
Regardless of the impact of OPEC's latest cuts, the EIA forecasts significant price increases over the next year. They forecast Brent and WTI to average about 10% higher than in 2023 and to rise roughly 15% from the new low. This puts energy companies in a good position to produce profitable growth relative to 2023.
The consensus estimate for Energy Select Sector SPDR Fund (NYSE: XLE) revenue and earnings growth reported by Factset is 2% and 4% compared to the double-digit declines posted this year. The estimates are likely low given the forecast for oil prices, so upward revisions are expected. The caveat is that economic uncertainty in inflation, interest rates, GDP growth in China, and two major wars could weigh on the outlook.
The price of WTI fell nearly 3% after the OPEC announcement, but it is already sitting at firm support. This level, near $75, has been tested numerous times in the last month and appears to be a bottom for the market. The indicators are set up for another bullish swing within the greater trading range, and it may begin before the end of the year. If the market cannot sustain support at $75, the next target is near $69.
