It looks like OPEC has managed to orchestrate a deal to cut production, albeit past the 11th hour. Oil prices have rallied over 8% today, following a 5% decline yesterday. While momentum is likely to keep prices rising in the short-term, we doubt that the rally can be sustained as the deal requires large non-OPEC participation. OPEC: Premature rally.
The OPEC group went back into closed session discussions at the time when the market was expecting an announcement. The market rallied 8% when it was waiting with baited breath and then some more when the announcement was finally made.
OPEC announced a 1.2 million barrels per day (mbd) reduction in production, from the current 33.4 mbd current production (excluding Indonesia). The group has suspended Indonesia, which currently produces 0.7 mbd and will be free to produce as much as it wants now. It is notable that OPEC increased the reference production volume, which it bases its cuts on (compared to the October Monthly Oil Market Report) by 0.471 mbd (after excluding Indonesia). Saudi Arabia is expected to make an ‘adjustment’ (OPEC nomenclature for a cut) of 0.486 mbd (i.e. the lions-share). Meanwhile Iran will be allowed to increase production by 0.09 mbd (notwithstanding the error on the published table which shows post-adjustment output lower than the reference production level). At the same time the group is relying on a 0.6 mbd cut from non-OPEC members. So market balance is still highly reliant on non-OPEC! The OPEC President claimed that Russia has committed to 0.3 mbd cut and other countries will make similar announcements in due course.
Based on this announcement, we believe that the market will return to balance in the second half of 2017. Beyond the initial euphoria, to see a sustained increase in price we believe that there needs to be visible signs of curbs in production (and that this announcement is not just empty rhetoric as we have observed in the past). To this effect OPEC has set up a monitoring committee and will use only secondary sources for production levels. But we fear the deal could unravel if non-OPEC countries do not reduce production as much as OPEC hopes.
As the details sink in, we fear that the recent rally will flop. The US$1 trillion cuts in capex will be the driving force behind market balance and a lot of that comes from non-OPEC countries. Not a lot has changed as a result of this meeting in reality apart from the admission that “market share at all costs” was a failed strategy.
Nitesh Shah, Research Analyst at ETF Securities
Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
