Tactical switch for Opec could be a win-win for oil market

Opec’s framework to rein in production by returning to a ‘market management’ strategy from its pump-at-will ‘market share’ strategy is likely to speed up the rebalancing of the crude market and push up prices, Paul Hickin, Editorial Director, Oil News & Analysis, S&P Global Platts told Petroleum Review. However, the home straight – from now until the agreement is hopefully finalised on 30 November 2016 in Vienna – will be the hardest road to travel.

The consensus to curb output to between 32.5mn and 33mn b/d could take more than 700,000 b/d out of the market and would drive oil prices as much as $10/b higher in 2017 if that reduction is sustained, according to Platts Analytics. Possibly of greater importance is the return of Saudi Arabia and Opec to active market management since it draws a line in the sand.

Opec, and in particular Saudi Arabia, now wants some respite from persistently low prices, hopeful that US shale will be reluctant to return with the same pizzazz as during the $100-plus/b era.

Nevertheless, US producers will be watching Opec with an eagle eye and the market will be watching US rig count data. US rig counts are predicted to grow by 29% in 2017 from the average estimated 449 rigs actively drilling in 2016 if the Opec deal is implemented, according to Platts RigData.

The recent $40–$50/b range has been a lose-lose situation – not low enough to grind the more economical and adaptable shale producers into the dirt and not high enough for Opec members to truly thrive. However, at $60–$70/b it could well be a win-win situation.

Sticking points
How to divvy up the output total among its members could be a sticking point, with Iran, Nigeria and Libya – which could add 1mn b/d in the coming months – treated as special cases given that they have been producing at sub-par levels. Also, each country’s output will need to be calculated based on secondary source estimates, to which Iraq is opposed, given that these are often lower than country self-reported figures.

Another challenge will be recruiting non-Opec members to join the cuts, as Opec only accounts for around a third of the market. Russia, producing more than 11mn b/d, may have been at talks in Algiers, but it neither has the will or ability to bring about significant cuts.

Even if somehow oil producer members can make the tough compromises, they will then need to stick to them. And, if history is a guide, that could be the hardest part of all, concludes Hickin.

Investor impact
Commenting on what Opec’s announcement might mean to investors in the oil and gas sector, Ben James, Partner, Bracewell (UK) LLP told Petroleum Review: ‘The oil and gas industry, including most importantly its current and prospective equity investors and debt lenders, is screaming out for two things. Firstly, and most obviously, the industry craves a return to the higher oil prices of yesteryear. However, more importantly, the sector requires some stability in the oil price.’

‘Whilst Opec’s decision to cut production levels is welcomed, in order for investors to regain the confidence to invest in the sector, there needs to be a sustained period of relatively stable global oil prices. If that happens, then deals will be priced and debt will be sized accordingly, which will unlock activity. Thereafter, executives will begin to forget the golden era of a few years ago and model their businesses on the basis of the new stable commodity price.’

Fiscal pressures
Meanwhile, noting that the accord has not yet defined individual quotas or other forms of accountability, Bank of America Merrill Lynch stated that the announcement represented ‘a soft output cut at best’. It also suggested that perhaps it ‘may be a way for Saudi Arabia to gain flexibility without losing face after a protracted oil market share war’.

The last time that the oil cartel announced a production cut was back in 2009, as global oil demand imploded. ‘This time around, the scale of the potential output cut and the fact that it was presented in the form of a production band suggests a very different strategy,’ said the Bank. ‘After all, Saudi Arabia has cut production seasonally by 320,000 b/d every year between July and January. The move in Algiers may reflect the impending fiscal pressures, as many Opec government budgets are starved for cash. Also, it is critical to remember that pegged currency regimes across many oil producers have put a huge strain on foreign exchange reserves in key Opec members.’

Despite the Opec announcement, after adjusting for higher Kashagan crude production and lower output from Opec, the Bank has left its forward oil balances roughly unchanged at a $61/b average Brent for 2017. ‘In essence, we believe Saudi Arabia will trim on the edges, but won’t propel prices much above our $70/b point target by end 2Q2017,’ it said.

The Bank also issued a few words of warning, noting that flow rates in the US Permian Basin have kept improving in recent months, meaning that US shale players keep learning how to do more with less. ‘Worryingly for the cartel, production in the West Texas region has already started to increase sequentially. Stated differently, Opec has declared a truce on oil prices. But relentless improvements in shale technology will keep Saudis awake at night wondering if they have made the right choice.’

Source: S&P Global Platts Opec survey