WTI is trading down $0.18 to $62.16 as of 840am MDT, but we would have expected WTI to be a little lower this morning following the Bloomberg TV interview with Russia energy minister Alexander Novak. On one hand, it makes sense as the headline from the Bloomberg posted story (and what everyone sees) and the video clip was titled “Russia Affirms Commitment To Oil Deal”. The headline fits to the consensus expectations for the cuts to continue at least to the end of 2018 with an increasing acceptance of Saudi Arabia’s guiding the market to expect continued cooperation into 2019. We wouldn’t have given it a second thought if we hadn’t listened to the short two minute video clip. Novak is saying that its hard to predict market balancing, but “we believe it might start to happen starting with the third or fourth quarter” and “as soon as the ultimate goal is achieved, which is the balancing of the market, we will start considering gradual withdraw or exit from this deal.” We didn’t expect oil to crash this morning but thought it would be a little lower as Novak points to the potential start to a gradual withdraw starting in Q3/18. This gradual start is especially so given last week’s IEA’s Oil Market Report that noted the surplus oil stocks were down to 53 million barrels above the 5-yr average as of Jan 31. Listening to the video clip is also a good reminder to do more than read headlines.
Novak says balancing could start in Q3/18 or Q4/18 and “as soon as the ultimate goal is achieved, which is the balancing of the market, we will start considering gradual withdraw or exit from this deal. It was short ~2 min video clip titled “Russia Affirms Commitment To Oil Deal”. [LINK] We created a transcript of the Bloomberg provided simultaneous translation. It is short so pasted the entire transcript. AN: “well, these are our assessments as well. we believe that at a certain point, the market will reach its balancing point. and there are different assessments as to the timing of that. so we believe that as soon as the ultimate goal is achieved, which is the balancing of the market, we will start considering gradual withdraw or exit from this deal. most importantly is that all the parties to this agreement are committed to achieving the ultimate goal of market rebalancing and, only after that, further actions are to be considered and taken.” Bloomberg: “so when do you see the market balancing?” AN: “there are different assessments on that. we monitor the situation closely and we believe it might start to happen starting with the third or fourth quarter, but again, its hard to predict anything right now. we need to watch closely the situation, particularly in spring or summer when demand is going to grow.” Bloomberg: “but will you raise the issue with your counterparts at OPEC to exit the cuts? AN: “we have all the opportunities within the framework of this deal to discuss various scenarios, and as we meet at the ministerial meetings and meetings of the monitoring committee, we discuss the current situation all the time and to discuss all the matters related. But in order to send the message, let me once again stress that, first of all, we are committed to obtaining the ultimate goal which we have put forth within the framework” Bloomberg: “Russian companies seem eager though to exit these cuts, they said, maybe the second half of this year, are you under any pressure from them to get out of the OPEC deal?” AN: “actually, we act in coordination with our companies. We are in constant dialogue with our companies since it is their decision and since it is the joint efforts I am talking about. And of course we listen to their point of view. But, once again, everything we do is a consolidated approach aimed at attaining the ultimate goal.”
Oil balancing by Q3/18 looks likely given the surplus is down to 53 million barrels at Jan 31. Novak’s comments that oil balance could be there by the start of Q3/18 should not surprise anyone. Last week, the IEA issued its Oil Market Report March 2018 titled “OMR: On balance” and it included its estimate that the surplus OECD oil stocks vs the 5-yr average were down to 53 million barrels at Jan 31, 2018. A year ago, in its OMR March 2017, the IEA wrote “At the end of January OECD stocks were 302 mb above the five-year average.” Last week, OPEC issued its Monthly Oil Market Report March 2018 that had a similar surplus estimate vs the 5-yr average of 50 million barrels at Jan 31, 2018.
Novak implies the right time to start the cuts is spring or summer when demand increases. Novak made a point of highlighting how oil demand picks up every year seasonally in the summer. He said ““we need to watch closely the situation, particularly in spring or summer when demand is going to grow.” The logic continues to be that the right time to start the exit the cuts is the summer so there isn’t a supply shock when the cuts are started to be removed. The problem with a Dec 31 end of cuts has always been that winter is the time when every year oil demand is lower seasonally. It is why we wrote our Dec 5, 2017 blog “The Only Logical Time For OPEC To Start To Unwind The Cuts Is In July To Avoid Recreating A Surplus Problem” [LINK]. We don’t believe the exit will be abrupt, but rather like Novak describes as a “gradual withdraw or exit from this deal”. The below table is a reminder of how oil demand is always higher every year in the summer than the winter.
World Oil Demand (mmb/d)
Source: EIA, IEA, OPEC, Stream Asset Financial
Exiting the cuts before the winter is also needed to accommodate Russia’s winter operating conditions. Novak highlights that he acts in coordination with the Russian oil companies. Russia is different from OPEC countries in that it isn’t a national oil company controlling all production, it is private oil companies like Rosneft. We believe it is tough for Russia to extend its cuts to Dec 31, 2018 because the cold winter temperatures in key producing Russian areas will effectively prevent a ramp up in production until Q2/19 ie. effectively extending the cuts to Russia to March 31, 2018. Also recall that Russia didn’t comply with the cuts until April 2017 due to the winter operating conditions. For the first three months of 2017, Russia had not really cut any volumes to its 300,000 cut commitment. Whereas on Apr 28, 2017, Reuters [LINK] reported on comments from Russia Energy Minister Alexander Novak that “There will be a cut by 300,000 by the end of the month”, and Reuters also reported “Novak said that on average, Russian oil production declined by 254,000 bpd from April 1-26 compared with the reference level of October”.
It continues to look like the OPEC/non-OPEC June meeting is set up to lead to the start of the exit, likely on a “gradual” basis as suggested by Novak. All bets will be off if Brent drops below $60 as the last thing Saudi Arabia wants is Brent below $60 for its Saudi Aramco IPO. But even through the normal lower seasonal demand period (likely helped by the cold winter), Brent has been stable around $65. The Nov 30, 2017 OPEC and non-OPEC Declaration of Cooperation extended the deal to Dec 31, 2017, but also included a June review. The DOC said “in view of the uncertainties associated mainly with supply and, to some extent, demand growth it is intended that in June 2018, the opportunity of further adjustment actions will be considered based on prevailing market conditions and the progress achieved towards re-balancing of the oil market at that time”. We expect there will be visibility in the June review, if not sooner, that the surplus to the 5-yr average will be soon gone, especially with the surplus being ~50 million barrels at Jan 31, 2018. If so, and with Brent relatively stable around $65, it sets up the conditions in the Novak Bloomberg interview comments and why we still believe oil markets are on track for the start of gradual or partial exit from the cuts n Q3/18 and not waiting until Jan 2019. We don’t see a gradual or partial exit from the cuts starting in Q3 leading to any material decline in oil prices.