David Dismukes, LSU Center for Energy Studies

On Nov. 30, OPEC heralded a new agreement to reduce the cartel’s collective production, in concert with many other large producing, non-OPEC states, by as much as 1.8 million barrels per day (“MMBbls/d”).

The agreement is important for several reasons. First, it shows that the cartel can, if pushed, herd its unruly members into a concerted production strategy, despite their differing interests. Second, the OPEC agreement is a de facto white flag of surrender recognizing crude markets are contestable and U.S. unconventional production is not going away.

Crude oil prices are now between $55 and $60 per barrel and the question on everyone’s mind is: Where do we go from here? The likely answer: Probably not very far. Prices have stabilized at levels that reflect underlying fundamentals, even though the conventional wisdom’s interpretation of these fundamentals may be right for all the wrong reasons.

The first fundamental to consider is the credibility of the OPEC agreement itself.  Everyone knows that cheating will arise. In fact, the conventional wisdom appears to be discounting the cartel’s commitment to a range of 70% to 80% of the announced reduction. If this holds, then the conventional wisdom may prove to be correct, at least in the near term.

The problem is that historic experience shows these agreements do not hold for long, and when they do fall apart, prices will start to fall. So while the conventional wisdom is likely wrong about the strength of the curtailment commitment, it’s hard to know by just how much—and when this commitment will start to unravel.

The second fundamental rests with U.S. production resiliency. Here, conventional wisdom may prove to be very wrong, since it discounts U.S. producers’ ability to quickly bring production to the market—even though prior to the OPEC agreement, U.S. crude oil activity was rebounding. Since Sept. 30, the U.S. has seen (1) the largest oil rig additions since early 2014; and (2) a 100,000 Bbls/d increase in domestic crude oil production turning up from its overall 8.4 MMBbls/d trough.

Conventional wisdom expects a U.S. crude oil production response of a tepid 200,000 to 400,000 Bbls/d. This could prove to be a significant underestimate, given the recent surge in drilling rigs and the fact that there are over 5,200 “drilled but uncompleted wells” that require very little additional investment to bring online.

The last fundamental is energy demand, and here the conventional wisdom may be right for all the wrong reasons. China has been in a state of “relative” malaise for the better part of the last year, but recent economic data has improved.  Unfortunately, this improvement, particularly in manufacturing, is being driven by recent government fiscal policies that drive up debt, leading to new monetary challenges that may undermine any revival in energy demand, contrary to the conventional wisdom.

What is less appreciated by the conventional wisdom is the changing fortune of the U.S. economy. Consumer confidence is up, manufacturing activity has been on a roll for several months, employment is reaching levels consider optimal, wages are increasing—all of which is leading to a post-election equity market run-up.

The Federal Reserve’s signal of future interest rate increases underscores this near-term optimism. This could mean that changes in U.S. energy demand will attract a level of attention that trumps what has been an exclusive focus on Asia and the developing world.

So, all things considered, crude oil prices are in a goldilocks position: one high enough to revive oil and gas activity, but not so high as to stifle economic growth. However, the information needed to ascertain whether the market is, or is not, in balance will be slow in materializing, leading to daily swings in prices as analysts and pundits read the tea leaves of each new data point.

While slightly higher prices appear supportable, at least for the early part of the year, volatility will remain.

David E. Dismukes is a professor and the executive director of the Center for Energy Studies at LSU. He holds a joint academic appointment in the department of environmental sciences where he regularly teaches a course on energy and the environment.

Originally published in the first quarter 2017 edition of 10/12 Industry Report