Oil prices fall after OPEC’s decision to leave output unchanged

Following the announcement by OPEC last night to keep output unchanged, the price of Brent crude continued to slump further to its lowest in four years at $72/bbl and WTI at $68/bbl.

Prior to the OPEC meeting, many market watchers were already expecting a marginal or no cut in production levels, given that OPEC is likely to take the strategic decision of seeking to maintain its market share in the face of rising US shale oil production. But with this official decision by OPEC, oil prices are likely to settle lower, impacting producers on the margin and reducing spending for projects that become uneconomic at the upper end of the cost curve.

Lower capital expenditure is expected to be seen in oil sands projects, certain US shale oil projects and certain deepwater and Gulf of Mexico/North Sea projects. The latter would translate to slower order flows for oil and gas related plays, hence we would favour companies with strong balance sheets and good track records to weather this downturn.

Given the still positive long term fundamentals, we maintain our NEUTRAL rating on the oil and gas sector, but more downside could be seen in the near term in light of macro developments.

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Industry - Oil and Gas Sector

Releasing strategic oil reserves in an election year?
Quoting French ministers, newswires such as Bloomberg and Reuters have reported that France is in talks with the US and Britain on a possible release of strategic oil reserves to push fuel prices lower. This is hardly a surprise considering that oil consuming markets have been bemoaning the continued rise in energy prices. Of note is the fact that 2012 will be an election year for both the US and France, and politicians may have to placate voters’ concerns about rising fuel prices.

But coordinated action is required
Oil reserve releases are usually coordinated by the International Energy Agency (IEA), and currently there are obstacles to such a concerted effort as
1) the head of IEA has questioned the need for a coordinated IEA release, and
2) support also has to be garnered from oil producing countries as it is possible that they may reduce production.

Merely a stopgap measure
Even if most of the international community does agree to cooperate, the issue of geopolitical tension in the Middle East has to be resolved. The flood of liquidity by central banks will also support prices of scarce resources such as