“We must strive to remain committed to our joint statements in the Declaration of Cooperation and ensure continuity. This is beyond attaining short-term market rebalancing, and calls for strengthening our cooperation through a dynamic and transparent framework for sustainable market stability in the medium- to long term.”
– Mohammad Sanusi Barkindo, OPEC Secretary General, at the 2nd Technical Meeting of OPEC and non-OPEC Producing Countries, 27 November 2017, Vienna, Austria.
OPEC has achieved many of its original goals from last year’s 170th Extraordinary meeting in Algiers, where they stated the OPEC-14 will “target (a) range between 32.5 and 33.0 mb/d, in order to accelerate the ongoing drawdown of the stock overhang and bring the rebalancing forward.” Back then, I wrote: “The combination of product demand and the implementation of OPEC production cuts could flip the curve from contango to backwardation and send oil prices towards $70 a barrel by the end of next year” (see my October 2016 blog post: Backwardation on the horizon… $70 in 12-15 months). The strategy is working… global inventories have drawn 140 million barrels (mostly from Asia, Europe and floating storage) since the implementation of the cuts, both oil curves are backwardated, and prices have stabilized. However, bringing the rebalancing forward meant sacrificing current and future market share. The US shale producer has proven to be a formidable opponent –resilient in the face of adversity, and now finally beginning to generate free cash flow at $50 WTI. On Thursday, OPEC and their non-OPEC counterparts will be faced with a quandary; given US shale steep production trajectory (supported by productivity gains and subsequently falling break-evens), any additional increase in production from the group will jeopardize the rebalancing, thus oil price stability.
Current market expectations are for an extension to the end of 2018 with little to no mention of tapering. Russian president Vladimir Putin and Saudi Crown Prince Mohammad bin Salman both agree on a nine month extension, however it seems that Russia is pushing for the production quotas to be dynamic, fluctuating with the health of the market and pace of draws. Yesterday Reuters reported that the joint OPEC/non-OPEC committee recommended an extension to the end of 2018, with the option to review in June. This “option to review” has not been reported elsewhere, though it could be an addition to appease Russia. An option to review in June could quite easily be interpreted by the market as a three month extension with the option to extend for six additional months in June. I believe the market would react negatively if this is the ultimate outcome. In addition to uncertainty around Russia’s position, Kazakhstan and Mexico have been unhappy participants. Kazakhstan actually increased production this year and has openly said they need an adjustment to the deal to accommodate for additional production from their Kashagan field next year. However, we might finally see Libya and Nigeria being brought into the agreement, with Libya signaling that they would be open to joining the agreement, albeit at a production cap of 1.3-1.4 mb/d and Nigeria’s constant mention of a voluntary cap. With so many moving parts, the table below is my attempt at weighing each outcome:
Given my table above and the bloated level of length in the oil market, I believe that risk is skewed to the downside. It is hard for me to believe that OPEC will do any (except removal of exemptions for Libya and Nigeria) of the bullish items listed in the table above.
Royal Dutch Shell recently announced that it will be restoring its all-cash dividend, while Anadarko, Hess and BP have initiated share repurchase programs. These are just a few examples of what two years of low prices have done… a focus on returns as management spent the last two years fixing balance sheets. One can only expect these types of actions to become more common throughout the sector. Though this new focus on cash flow could translate to a less aggressive ramp up in production, oil producers continue to emphasize their ability to increase production at $50 WTI. The market will be reminded of this in the next few months when 4Q17 US oil production growth comes in at 12% Q/Q, per company guidance. For OPEC to, in its own words, “remain committed… and ensure continuity… for market stability in the medium- to long term” it MUST maintain production cuts not only at this meeting, but at subsequent meetings thereafter. OPEC will have to wait for the rate of shale production growth to mature and decelerate, or risk oil price instability.
OPEC Program for Thursday, November 30
Opening session OPEC conference, attended by OPEC heads of delegation, delegates, and journalists – 1000 Vienna time (0400 ET)
Closed OPEC session – 1200 Vienna time (0600 ET)
Vienna Group (OPEC and Non-OPEC) meeting – 1500 Vienna time (0900 ET)
Followed by joint news conference by the president of the OPEC conference, Russia’s energy minister and the OPEC secretary general.
Latest version can be found here: http://www.opec.org/opec_web/en/311.htm