OPEC and non-OPEC tighten their belts

Focusing on details was never likely at the spring OPEC meeting in Vienna. The group decided to extend the current cut by nine months. Instead of concentrating on specifics, the meeting and press conference seemed to be arranged to create the impression of a strong alliance between the world’s two largest crude oil producers, Saudi Arabia and Russia.

One man show: Al Falih

After one year in office and clearly the architect of the existing cutback strategy, Saudi Arabia’s oil minister, Al Falih, is now the protagonist at the OPEC Secretariat. Al Falih is working closely with his Russian counterpart, Novak. They raised market expectations ahead of the meeting through a joint press conference in China. After opening up for a ninemonth extension, other countries had little to do but follow. We believe Al Falih and Novak synchronised information leaks to the media. In addition, they arranged a joint session between OPEC and non- OPEC countries at the official OPEC meeting. To further spread the word of the new alliance, the world’s two mightiest oil men dined together in Vienna the day before the meeting. Naturally, they gave a short speech when ‘spotted’ by the media.

Mountain out of a molehill

“Too much talk, too little cutting production” is the reaction after the first round agreement on cutbacks. OPEC has failed to clear the market glut. However, we believe the curbs and conversations are working toward bulging the coffers of oil producing nations.

The size of the cut is only a fraction of the well planned/timed cutbacks of the Asian crisis in 1998, the dot com recession in 2001, and the global financial crisis in 2008. This time, weak oil prices stem from growing supply, rather than weaker demand, leaving the cartel toothless. If OPEC genuinely wants to drive oil prices, we believe it needs to make a deeper cut. At this stage, it appears it is not prepared to bare the cost.

In our view, shale oil is growing too fast and any OPEC change must be well balanced to further avoid accelerating growth in US crude oil production.

Same conditions

Iran, Nigeria and Libya are subject to the same exemption conditions as in the original accord. We believe Libya’s potential recovery is a possible risk, and could undermine cuts from the producer group. Libya and the US have so far erased the lion’s share of OPEC cuts in the first part of the accord.

Weak outlook

In our view, a rollover without a promise of further extension does not correspond to the “whatever it takes” assertion from Al-Falih. If the deal unravels, we believe the cut of more than 1.2 million bbl/d will flood back into market, causing prices to crash, again. The nine-month extension should help to bring about a modest deficit in the oil market, supporting a floor prices. We estimate USD 50 as a reasonable price during that time. However, ultimately, we believe the market will start to test OPEC’s endurance. In our view, prices will start drifting toward USD 40 once more, if the stock overhang persists.

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