How the OPEC Deal Impacts the Offshore Drilling Industry
On November 30, 2016, OPEC concluded a deal to curb oil production. This was first time in the last eight years that the member countries agreed to an oil production cut. According to the deal, OPEC member countries would slash production by 1.2 million barrels per day. Also, non-member countries agreed to cut production by 600,000 barrels per day.
These production cuts will become effective on January 1, 2017, and would last for six months. A further six-month extension is possible. The oil price plunge, which started in late 2014, was mainly due to an oversupply of oil. This production cut could push oil prices up.
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The US benchmark WTI crude oil reached $54.06 per barrel on December 28, 2016, the highest in the last 18 months. Oil prices have risen ~25% since mid-November.
Oil prices and the offshore drilling industry
Lower oil prices hamper cash flows and profitability of oil companies. Offshore drilling (OIH) (IYE) demand is driven by the capital budgets of these oil companies. Their budgets are based on expectations of future oil prices as well as current profitability and the availability of free cash flows.
When oil prices are expected to rise, oil companies raise their capital expenditures. Similarly, when oil prices are expected to fall, oil companies lower their capital spending. When spending rises, the demand for rigs also rises, and vice versa.
These changes in spending and demand can impact offshore drilling industry companies such as Ensco (ESV), Seadrill (SDRL), Noble (NE), Transocean (RIG), Atwood Oceanics (ATW), Diamond Offshore Drilling (DO), Rowan Companies (RDC), and Pacific Drillers (PACD).
To learn more about the relationship between oil prices and the offshore drilling industry, please read Understanding the Demand Side of the Offshore Drilling Industry.
Oil price forecast
As OPEC members and other countries made the decision to curb oil production, Goldman Sachs revised its crude oil price forecast for 2Q17. Goldman Sachs raised the forecast for 2Q17 from $55.00 to $57.50 per barrel. It also raised the oil price forecast for Brent crude oil from $56.50 to $59.00 per barrel.