OPEC deal to cut 1.2 MMBOPD could return market to balance in the first half of 2017
Crude oil prices surged Wednesday following news from OPEC that the group agreed to cut 1.2 MMBOPD of production after two years of producing near capacity in a bid for market share. OPEC agreed to cap production at 32.5 MMBOPD, which, along with agreements form non-OPEC members to reduce production by 600 MBOPD, should reduce global output by 1 percent.
Market watchers were uncertain which way the meeting would go after months of negotiations between OPEC members about how much to cut, and where. Much of the tension surrounded regional rivals Saudi Arabia and Iran – the organization’s first and third largest producers, respectively. Talks to freeze production had been sunk before by disagreements between the two, and many worried that Iran’s insistence to return its production to pre-sanction levels would prevent today’s deal as well.
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Today’s deal signifies a turning point for OPEC, however, with Saudi Arabia agreeing to Iran maintaining its current production while the kingdom and other members of OPEC make production cuts. As part of the deal, Indonesia has suspended its membership in OPEC, allowing Iran to set its production cap at 3.797 MMBOPD almost 3 percent higher than the 3.69 MMBOPD it produced in October.
“Before, we were thinking that, optimistically, we could reach market balance at the back-half of 2017 or the front-half of 2018,” Wunderlich Director of Equity Research and Chief Market Strategist Art Hogan told Oil & Gas 360 today. “Now I think we can get there in the front-half of 2017.”
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Source: Bloomberg. Brent and WTI crude price 3-day chart
Danger remains, but likely not from OPEC
One of the major concerns following today’s deal is whether or not OPEC members will actually comply with the deal reached in Vienna. The group has a poor record of upholding production cuts, with Saudi Arabia often shouldering the majority of the burden. Given that OPEC has continually increased production over the last two years and is now likely producing near capacity, the group has little room to cheat, said Hogan.
“Saudi Arabia will probably shoulder the bulk of the burden, but the rest of OPEC will be producing at levels similar to where they are now, except for maybe Iraq,” he explained. “But if there’s cheating, I suspect that it’s going to come from a non-OPEC countries that say they’re complying and are just along for the ride.”
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As part of today’s deal, it was announced that Russia plans to cut its own production by 300 MBOPD, while other non-OPEC producers will reduce their output by a collective 300 MBOPD, and possibly more. Whether or not Russia and other non-OPEC producers will follow through on this promise remains to be seen, however.
“The risk here, in my mind, is not non-compliance, but how strong the dollar gets,” said Hogan. As the dollar increases in value compared to other currencies, it becomes more expensive for buyers to purchase dollar-denominated commodities like crude oil. Related: Is This The Mastermind Behind The OPEC Deal?
“The dollar will probably strengthen in 2017, but not at the same rate that we’ve seen in the last three weeks. The recent strength is a knee-jerk reaction to a Fed that is clearly going to be tightening,” Hogan added, saying that the currency markets usually do a good job of self-correcting.
Source: Bloomberg. U.S. dollar compared to a basket of 10 currencies over the course of November 2016
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For Saudi Arabia and OPEC, deal was a must
With regional rivals able to compromise, it appears that relations between Saudi Arabia and Iran might be improving, but today’s deal was reached out of necessity, former Ambassador to Oman and CEO of Equilibrium International Consulting Gary Grappo told Oil & Gas 360®.
“This was a very decisive moment for OPEC. If they had been unable to reach this agreement, they would have lost all credibility with the international economic community,” said Grappo. “Not only would the lack of a deal reflect poorly on OPEC, but also on Saudi Arabia, which is seen as a major player in the international economic community in part because of its influence in the group.”
“The agreement was clearly in the interest of both Saudi Arabia and Iran. Iran wanted to preserve the ability to resume production at pre-sanction levels. They settled for a bit less,” but increased prices will help both countries.
Saudi Arabia and Iran will likely remain divided on other key issues like the wars in Yemen and Syria, with today’s agreement coming down to business rather than improved political relations, according to the ambassador.
“My suspicion is that Saudi Arabia may have been ramping up production ahead of this, knowing they would have to take the biggest cut. They are facing significant budget pressure, and they are looking for ways to minimize that now.”
Improved oil prices will also help the kingdom with the pending IPO of a portion of state-owned Saudi Aramco. With improved oil prices, Aramco will appear as a more attractive investment opportunity, meaning more capital for the kingdom to move forward with its plans to diversify its economy.
“I suspect the driver behind this was Deputy Crown Prince Mohammed bin Salmon. They needed Aramco to look attractive to execute Vision 2030,” said Grappo.
So where will oil prices go in 2017?
On Nov. 27, Wells Fargo issued a research report discussing possible outcomes in advance of the Nov. 30 OPEC meeting. Their general oil price summary follows:
“For 2017, we remain comfortable that oil prices will continue to slowly recover towards a near-term equilibrium of $55-60/bbl by H2 2017. Providing confidence for this outlook is the recent trends in global inventory data which indicates modest declines in OECD crude oil and product inventories since mid-2016. It is also important to note in our view that our supply/demand model implies that inventories should have grown by approximately 180 mmbbls yet actual inventory growth is less than one-third that volume. The clear takeaway – the global oil market is a bit tighter than anticipated year-to-date in 2016. Higher demand, lower supply or some combination of the two is the simple and straightforward explanation. Regardless of the how, we believe this is a situation likely to persist into 2017.”
“As a result, our oil price deck is approximately $3-4/bbl above consensus in 2017 with the majority of the separation occurring in H2 2017. That said we are nowhere near the optimistic crowd which foresees oil rising well above $70/bbl for an annual average. In our view, there is simply too much oil available for development and far too much in easy access storage for oil to sustain above $70/bbl for a full year. Also, we are skeptical that demand growth would be immune to a near doubling of oil prices from the 2015/2016 averages.”
By Oil & Gas 360
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