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OPEC meeting to discuss the easing of production cuts, fireworks anticipated?

  • Oil prices rise amid planned cuts as per OPEC’s Algeria Accord
  • Supply gap risk in the middle of Venezuela and Iran geopolitical crisis add premium to crude oil

                                        

In Televisory’s earlier blog, a detailed analysis was presented on how oil prices spiralled down between 2014-16 as global markets tussled with an oversupply of the black liquid, while global demand remained relatively stable, thereby, leading to a surplus situation. The OPEC rolled out a strategy in November 2016 as per the Algeria Accord and implemented this from January 2017, which has so far positively supported the prices from the lows of $40-50/barrel in 2015-16 (oil touched rock-bottom levels of ~ $27 in early 2016). OPEC, along with a few other oil producing nations from outside the cartel decided to cut down the production by an aggregate of 1.8 MBPD (OPEC 1.2 MBPD, non-OPEC 0.6 MBPD) in an attempt to reduce the global supply glut. Moreover, in spite of the market scepticism, a high compliance level towards production cuts was adhered to by most of the OPEC and non-OPEC members, which helped in the successful implementation of the plan.

Further, OPEC has continued to maintain the production cut targets in its latter two meetings (2017), which aided to the oil market’s sentiment. The members are again set to meet on June 22-23 (2018) at Vienna in order to discuss the future course on the production policy for both the OPEC and few non-OPEC members such as Russia. Furthermore, as the world awaits an outcome of the meeting, speculations are rife with divergent interests and demands from the members will play a crucial role. Analysts around the world are expecting an acrimonious meeting similar to the one held in 2011. The gathering back then witnessed an infighting and strong disagreements emerged between the members on tackling high oil prices (tune of $100 plus/barrel). While the Gulf states were in favour of an increase in the production to ease the prices, a few others like Venezuela and Iran preferred to maintain the supply in order to enjoy the booming prices. In 2018, the group is at the same juncture as it was in 2011.

Fundamentally, in the core OPEC group, no country other than Saudi Arabia, Kuwait and UAE (to an extent) even have spare capacity to support ease in production cut. Geopolitical strains have also affected the oil output of certain countries. For instance, Angola’s production is rapidly falling, while Libyan and Nigerian governments are unable to ensure a steady supply due to ever-looming security risks. Venezuela’s oil industry is on the verge of collapse owing to severe political and economic crisis. Further, vis-à-vis assigned reduction cut of 95,000 BPD, Venezuela’s output has fallen by a whopping ~600,000 BPD to 1.392 MBPD in May 2018 and from over 2 MBPD during early 2017. Market estimates also shows the actual supply from Venezuela is likely to further decline around 1 to 1.2 MBPD by the end of this year (2018), potentially pushing for a cut of 1 MBPD in the global oil markets over and above the planned cut by the OPEC. Iran, on the other hand, is facing renewed sanctions from the US on oil exports and therefore, will probably face a drop in its output. In the beginning of 2016 when the P5+1 countries lifted sanctions against Iran, the nation was producing ~2.8 MBPD worth of oil, this has gradually increased to ~3.8 MBPD in the past 2 years. The global oil market faces a risk of a shave off of around 0.5-1.0 MBPD worth of oil from Iran, in case other countries too join the bandwagon. While EU and other nations have so far raised reservations against the US’ abrupt move on Iran and are more skewed towards dealing with the issue through discussions and clarifications, but the US government does not seem to be in a mood to budge. Apparently, if the US takes a moderate stance, it could still, lead to a few hundred thousand BPD worth of oil supply cut globally. In fact, both these factors: Venezuela’s falling numbers and potential loss of output from Iran amid the US sanctions drove the prices higher with Brent touching ~$80 per barrel in the month of May, its best levels in 3 and ½ years.

Further, looking at the broader oil market perspective, even before a sudden and strong rise in the oil prices in the month of May, voices have been rising from different corners over easing supply from OPEC. The US President, Donald Trump accused OPEC of manipulating oil prices in a belligerent tweet in April. This weighed on Saudi Arabia and also indirectly on Russia to start preparing for an ease on the production ceiling. According to Bloomberg reports, the US officials were also involved in discussions with Saudi Arabia and few OPEC nations in the past couple of weeks, where they have sought for a production increase in the range of 1 MBPD.

In the forthcoming meeting, Russia, in particular, is expected to push for an increase in production. The Russian president, Mr Putin recently stated that the ‘arrangements were never intended to remain in force forever’. In addition, even few Russian companies have been publicly calling for a greater flexibility in production. It has also been reported that Russia is already boosting its production ahead of the Vienna talks. According to a report by Russia’s Interfax: production of 11.1 MBPD was registered in the current month (June 2018), which is higher than the 10.95 MBPD ceiling previously agreed upon. The country has also indicated that $60 per barrel best suits its interests and is a healthy price for consumers. Among the OPEC, mainly Saudi Arabia, which is a member with surplus capacity seems to be in a favour of an increase in the output. Although, others such as Iraq, Iran and Venezuela are expected to vehemently oppose this move as it would reduce their market share in the global oil production whilst an increase in supply is anticipated to ease the risk premium the black liquid is presently commanding. Technically though, these countries lose out on both the fronts, while the production is already lower (or going to be lower), price loss would further add to their fiscal burden.

Televisory believe, the easing of production quotas might be implemented in stages:  an initial addition of ~0.5 to 0.75 MBPD worth of oil could be rolled out immediately, with a planned production increase totalling up to 1-1.5 MBPD to be achieved gradually. Whereas, a further planned production rise of up to 1-1.5 MBPD can be done in stages. A strong possibility of a consensus among the OPEC members is quite bleak, the big brothers (Russia and Saudi Arabia) might take their own call even if others oppose. Nevertheless, OPEC as a whole has to play this very cautiously as, in the other part of the world, production from the US, especially, backed by the shale is rising again. According to the EIA weekly update, crude oil production in the world’s largest economy surged to a record of 10.9 MBPD during the first week of June. In a highly unlikely scenario, if production ceiling is continued, crude oil prices might remain near the current levels or even gain moderately further adjusting for the supply risk premium from other OPEC members (mainly Iran and Venezuela). Already, ICE Brent has moved higher by ~14% in April-May, wherein it touched ~$80 per barrel before falling modestly to ~$75 per barrel on an expectation of weakening supply from the two nations. Notably, the major gainer in this scenario would be the US as it continues to increase output while all the consuming nations face the heat.

Our bias stand towards a production increase from the OPEC is anticipated to put weight on crude oil prices in the short to medium-term. One might see Brent scaling back to $60-70 per barrel range by the end of this year.

Risk factor against our view – higher than expected loss in production from Iran, Venezuela and other smaller OPEC partners.

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