As expected following comments ahead of the meeting on behalf of Saudi Arabia and Russia, OPEC members have agreed to prolong the existing production curtailment (a cut of 1.8m bbl/d including Russia’s cuts) to the first quarter of 2018. OPEC has a self-imposed goal of bringing stocks down from a record high of 3bn bbls to the five-year average of 2.7bn bbls.
Both Brent and WTI traded around one-month highs ahead of the OPEC meeting, but were tempered when Saudi Arabia’s oil minister played down further reductions in any new OPEC output deal.
Following the meeting, we have seen both Brent and WTI trading a touch lower (c.0.5%) on the news as a proportion of the market had priced in the potential for deeper cuts, however this failed to materialise – a case of buying on rumor and selling on facts.
There seems to be a little resistance on the price at US$55/bbl, however if OPEC members and a selection of non-OPEC members, notably Russia, abide by the supply cut, the price could conceivably hit US$60/bbl by year end.
It’s also worth noting that the Saudi Arabia is in the process of listing Aramco (the national oil company), and will therefore require a stable oil price to support their US$2tn valuation of the company, and so it is in their interests to continue with a production cut to do so.
A stable oil price in the current range is also good news for IOC’s and independents alike with companies reporting their highest quarterly earnings since the 2014 crash. At the smaller end of the company market we believe the flurry in M&A transactions will continue. Low oil prices for upstream producers are a window of opportunity to buy needed reserves and drive down costs by optimising geographic and business combinations. Sellers would monetise properties to repair balance sheets and lower costs through increased efficiencies gained by focusing on core assets.
A stable oil price will serve to boost equity markets with increased capital flowing towards the sector. In addition, with global growth demonstrating solid progression, consumption levels are increasing – therefore contributing to the supply/demand re-balance.
Conversely, an increasing GDP growth rate has a commensurate impact on commodity pricing, which is largely driven by sentiment as opposed to fundamentals. We would therefore expect a medium term squeeze on pricing levels as output cuts meet economic demand.
The key risk to the downside continues to stem from growing US production, which threatens to replace the cut in supply from Saudi/Russia. A further 8 US oil rigs were added last week, bringing the total count up to 720, the most since April 2015, and it is very likely this trend will continue at current oil prices. U.S. output has increased c.1m bbl/d to 9m bopd, placing the country’s output alongside Saudi Arabia and Russia, thus somewhat diluting OPEC’s ability to play a role in setting prices and supplies.