WTI closed up $3.69 to $49.02 following the OPEC deal. Our blog last night was written as of 7:30pm mountain time with the market moving more to a no deal view believing Saudi Arabia was likely to do like they did at Doha in the spring and pull out. It looks like Saudi Arabia blinked. The momentum shifted to an OPEC deal this morning, when going into the ministers meeting, Saudi Arabia Oil Minister al Falih was discussing major OPEC cuts and said “It will mean that we (Saudi) take a big cut and a big hit from our current production and from our forecast for 2017”.
What are the key elements of the deal?
OPEC issued an agreement press release, but there was added color in the press conference Q&A, as well as the separate press releases to close and open the meetings.
- Bring the OPEC ceiling to 32.5 mb/d, which is a reduction of “around 1.2 mb/d”. In the Q&A, OPEC confirmed that that 32.5 mb/d ceiling was for OPEC 14 ie. including Indonesia’s volumes.
- Effective Jan 1, 2017 with initial term of 6 months.
- Extendable for another 6 months to “take into account prevailing market conditions and prospects”. In the Q&A, OPEC said it will be reviewed at the next meeting (May 25) but the “intention is to extend for 6 months”.
- Non-OPEC expected to cut 0.6 mb/d. “This agreement has been reached following extensive consultations and understanding reached with key non-OPEC countries, including the Russian Federation that they contribute by a reduction of 600 tb/d production”. In the Q&A, OPEC described the OPEC cut as being “subject to” the non-OPEC cut, but then wouldn’t say what they would do if non-OPEC fell short. Rather said more likely to be higher than the 600 tb/d. In the Q&A, OPEC said Russia was making 0.3 mb/d or half of the non-OPEC cut.
- The reference (starting) OPEC volumes by country look to be primarily from OPEC’s Monthly Oil Market Report Nov 2016 based on “secondary sources” with the exception that Iran’s reference number is 0.275 mb/d higher at 3.975 mb/d. Below is a table comparing the OPEC deal to the previously reported OPEC volumes as per “secondary sources”. Note that the OPEC agreement shows the +90 (not a cut an increase) for Iran, but the press release total didn’t add up, whereas our table does the calculation correctly.
What will this do to the current oil oversupply?
Cheating aside for the moment, the OPEC + non-OPEC cut deal for 6 months would reduce the oil oversupply by 208.6 million barrels, which would more than eliminate the 113.8 million barrels YoY surplus, or 2/3 of the >300 million barrels surplus to the 5 year average. Extending the deal for 12 months would see all of the 5 year surplus eliminated and more.
We put together the below table to show the potential impact to reduce the current global oil inventory surplus. As of Sept 30, OECD global oil inventories were 113.8 million barrels up YoY, and over 300 million barrels up vs the 5 year average. The key assumptions to the below table are: (i) Estimated demand, non-OPEC supply and OPEC NGLs from IEA’s Oil Market Report Nov 2016. (ii) OPEC’s Oct oil production from OPEC’s Monthly Oil Market Report Nov 2016 for “secondary sources”. (iii) Sept 30, 2016 OECD crude oil inventory from IEA’s Oil Market Report Nov 2016.
What are the criticisms to the deal?
Outside of the cheating question, there really aren’t that many criticisms on the deal itself.
- Is the non-OPEC 0.6 million b/d cut achievable and will it be real? In the Q&A, OPEC said they expected that it could be even been higher, but only noted Russia was in for 0.3 mb/d and no other countries were named. Who else is cutting? The skeptics will be on how real the cuts will be if countries like Azerbaijan says they are cutting. The IEA demand estimates for 2017 already incorporate declining Azerbaijan oil production in 2017. So these are already in the numbers. Plus is Russia cutting or just not agreeing to grow?
- Markets are reflecting cheating and rightly so as the history of OPEC is quota, then cheating, then the need for another quota, etc. The cheating discount will stay in oil prices and the market fears of cheating will increase as oil prices go up. The surprise of today’s deal was the inclusion of the non-OPEC 0.6 mb/d cut. It almost provides a cushion for cheating. As noted below, a 1.8 mb/d cut is huge for oil prices, but even a 1.2 mb/d cut should send oil prices well above the strips.
If OPEC can pull this off for 6 months, it sets up oil to go over $60 in H2/17
Markets are reflecting skepticism about the deal. WTI strips are ~$52 for 2017 and $53 for 2018. Yet, it OPEC can pull this off for 6 months, the global oil inventory surplus can be reduced by >200 million barrels. We believe this would set up oil to go above $60 in H2/17. Even reducing the YoY surplus of 113.8 million barrels should get oil above the strip and to hit the mid $50’s in H2/17.
Our closing food for thought comment is that OPEC’s oil price ambition may be even higher than $60 if OPEC is truly serious about reducing oil inventory to 5 year levels ie. eliminating >300 million barrels from the oil inventory oversupply.
The key sentence in the press release announcing today’s deal is: “The numbers underscore that the market rebalancing is underway, but the Conference stressed that OECD and non-OECD inventories still stand well above the five-year average. The Conference said it was vital that stock levels were drawn down to normal levels.” If OPEC is thinking that the normal is the 5 year average (which makes sense) and they want to get there, this becomes the oil price scenario that goes well above $60. In the release at the start of the meeting, OPEC reminded that oil inventories are more than 300 million barrels above the 5 year average.
In the Q&A, OPEC stressed that the intention is to extend the deal for another 6 months. No one will believe it and most will just ignore it. But if they mean the 5 year average oil inventory is the normal and they want to get to normal, then they can get there with ~9 months of the deal including non-OPEC. We believe oil would go well above $60 if they can wipe out 300 million barrels. So perhaps OPEC’s ambition is much more than $60.