OPEC will cut oil output but ‘fudge factor’ runs – Market watchers reckon deal may pack less punch than Saudi and partners want

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VIENNA, Austria, Nov 25, (RTRS): Oil prices have risen to their highest in nearly a month, as expectations grow among traders and investors that OPEC will agree to cut production, but market watchers reckon a deal may pack less punch than Saudi Arabia and its partners want.

Brent crude has risen 6.5 percent in the last two weeks, hitting nearly $50 a barrel for the first time since late October, with Saudi Arabia embarking on a last-minute push for unanimous agreement to cut output when OPEC meets next week.

The Organization of the Petroleum Exporting Countries said in late September in Algiers that it would limit output to a range of 32.5-33.0 million barrels per day, compared with October output of 33.8 million bpd.

OPEC members seem to accept that Libya and Nigeria should be left out of any deal, as the two countries struggle to raise output curtailed by violence, but there are still a number of hitches the group must overcome.

Iran has said it would accept an output cap at 4.0-4.2 million bpd, compared with its current level of around 3.6-3.7 million bpd as it ramps up production after years of Western sanctions that were lifted in January.

Iraq, OPEC’s second-largest producer, says it should be allowed to raise output to bring in revenues to fund its fight against Islamic State militants.

Russia, one of OPEC’s largest individual rivals, has said it sees no problem with freezing its oil production, which has hit post-Soviet highs above 11 million bpd this year.

The United States, Canada and China, three of the top five non-OPEC producers, have not been involved in any such discussions and are unlikely to join any deal.

The consensus among oil-market watchers is that there will be a cut on Nov 30 when OPEC meets, but it risks being less effective than Saudi Arabia and its partners may be hoping.

“No ground-breaking agreement on production caps or cuts should be expected from the OPEC meeting. The oil market is likely to remain oversupplied for some time yet even after the OPEC meeting, especially since US oil production will soon start rising again.”

“Ultimately, it looks as if Saudi Arabia and its allied Gulf neighbours will reduce production on their own, though only on condition that the other OPEC states do not step up their output. At the current time only Iraq would be in a position to do so in any case, and it has yet to declare its intention. It is unlikely that Libya or Nigeria would expand their oil production in any significant and lasting manner in view of the fraught security situation that continues to persist in both countries.”

“For the purpose of our oil price forecast, our base case is now that an OPEC production cut will be announced and implemented with OPEC production at 33.0 million bpd in 1H17 and a Russia freeze at 11.6 million bpd.”

“Specifically, normalizing inventory levels will generate backwardation by 2Q17 and leads us to raise our 1Q and 2Q17 WTI price forecasts to $55/bbl from $45/bbl and $50/bbl previously. We however reduce our 3Q and 4Q17 forecasts to $50/bbl (from $55/bbl and $60/bbl previously) on an expected resumption in OPEC production growth and a US shale supply response to the 1H17 rally.”

“We still expect OPEC to agree to a face-saving statement. It would showcase agreement, provide flexibility, and not veer too far from what countries had planned initially for 1H17.”

“Now, with extra supply on the market a deal looks much more challenging to achieve. At the same time, a stronger dollar and far lower oil prices mean the pressure to turn the tide might be even more intense now than in Algiers. Should a credible deal prove out of reach, only the normal uptick in winter demand could save the market from declining further.”

Production

“We continue to believe that a meaningful agreement to cut production is very unlikely. More recently, OPEC production has risen to new record levels, showing that petro-nations are in need of cash flows to plug budget deficits. The common denominator for negotiations remains small and any deal would enter rough waters shortly after signature. Historically, sacrificing oil revenues has been too bitter a pill to swallow for most petro-nations.”

“A failure to agree some sort of deal would be such a disaster that it is almost unthinkable. Having built up expectations it would be suicidal to end the meeting in disarray. It is also equally difficult to believe either that Iran/Iraq or the Saudis will completely capitulate.”

“The most likely outcome is therefore some sort of gruyere type fudge, thinly covered in chocolate but delivered with conviction as a breakthrough. Given the uncertainties any subsequent price spike should be considered a golden opportunity for producers to add to their 2017 hedging programmes. Oil has a supply problem — there is simply too much of it!”

“Key OPEC roadblocks include: 1) internal dissension on which countries should be exempt; 2) how production cuts should be allocated and 3) which production numbers should be used. Iran and Iraq are key players in the negotiations and will be critical to watch.”

“If OPEC fails to announce any agreement come Nov 30, there could be a sharp correction in prices, which OPEC knows.

Therefore, our base case remains a group quota (similar to 2012) that lacks country specifics or leaves several notable exemptions given the disagreements.”

“A supply freeze does not seem much in pure mathematics but if it comes with convincing statements that de-facto it brings spare capacity to zero, then it will allow the market to price a greater risk premium, i.e. increase the cost of holding short positions.”

“Given that OPEC seems to want a price range of $55/bbl to $60/bbl it is likely that if a deal is confirmed next week, it will also come with statements to convince the markets that a new policy era is starting.”

“We estimate the possibility of an actual OPEC production cut as 50-50. On one hand, several OPEC countries, including Libya, Nigeria, Venezuela, Iraq and Iran indicated that they are not intending to lower oil production for several reasons. Perhaps even Saudi Arabia has some mixed feelings about cutting oil production for economic reasons. However, after the failure of the Qatar meeting earlier this year, the new Saudi oil minister would like to show the market that OPEC/Saudi Arabia is still in control and is willing to stabilise the oil markets.”

Market

“There is a possibility that OPEC surprises the market with a (bigger-than-expected) production cut. In fact, at this point, any type of agreement would surprise the market. And if OPEC would stick to its intention to set its production ceiling at 32.5 mb/d (or even lower), market optimism will likely pick up, which could be supportive for oil prices. However, such a scenario does not seem very likely, and even if such a deal would be reached, we expect the effects to be only temporary.”

“If OPEC decides to trim production at its meeting on 30 November in order to protect the downside of $45/b, then this will probably be fine. However, if OPEC decides to trim production in order to drive the oil price north of $50-55/b, then it is running a dangerous game.”

“While OPEC should wait and see, Saudi Arabia should state that it unilaterally will trim production if the price moves below $45/b. That is a fairly safe game since at that price the US shale oil rig count will likely be at a steady state rather than expanding. Holding it there will then lead to a gradual rebalancing of the market as consumption continues to grow.”

“On balance, we still believe that OPEC will succeed in finalising and implementing the agreement by the end of November.”

“At this point, still without any details, our initial “back of the envelope” calculation for a real crude output of 0-0.5 million bpd is still reasonable. If we take the 0.25 million bpd midpoint as the real cut, and adjust our new forecasts, we would get a 0.25 million bpd global stockdraw in 2017.”

“We are reiterating our call that the OPEC deal has a 60 percent chance of success on Nov 30 with a low $50 price range on success and low $30 on failure. Despite back and forth news flow, we believe the deal will happen.

“…If OPEC fails, they will be The Boy Who Cried Wolf, Bill Buckner and the Mayweather-Pacquiao fight all rolled into one. Additionally, OPEC would lose jawboning power immediately and be on its way to dissolution while members are locked in a crude production arms race.

“Failure would force members to maximize production resulting in large increases from Saudi Arabia, Iraq, UAE, and eventually Kuwait. In this scenario, we believe OPEC could quickly get to 34.5 and even 35 million bpd and create oversupply for all of 2017 and part of 2018.”

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