Last week, OPEC+ ministers managed to come to a consensus after days of contentious discussions in Vienna, achieving the goal of formally keeping the OPEC+ alliance together, but failing to solve some of the thorny issues between key members including Saudi Arabia and Iran. The final agreement, which commits the group to reversing recent overcompliance to boost production, remains formally agnostic on who will contribute to that production increase. This post looks at the factors that will shape upcoming fundamental outlook and assesses the macro impact for some key producers.
This suggests the alliance has moved into a transition phase of exit and shift to a different and more contested data dependent mode. The time-buying (or can-kicking) deal allows for more time to assess several key supply and demand variables described below including the impact of sanctions, the politically driven pressures and the resilience of global consumers.
In the near-term, the results support higher prices, especially as the net addition of fuel will be modest, and the result of individual decisions. Additions from the countries which can add will likely to offset by continued Iranian export declines as businesses trim their imports ahead of key November sanctions dates. The uncertainty around supply and risk of unilateral action to make up the gap. increases the likelihood of volatility and production.
Overall the result mapped with my expectations of gradualism, a moderate increase now, with ongoing reassessment and eventual gains through the year. As noted in our coverage of the Iran deal exit, OPEC members were likely to add supplies slower and more modestly than some market actors expected, while bargaining and price discounting from the Iranians would complicate assessment of production. The political pressures and uncertainty on production outlook in several key countries (including Venezuela, Iran, Libya, Nigeria), make it hard to imagine a different outcome, but divides will build over time, as further outages build in countries like Iran and Venezuela and only a few countries can produce more in compensation.
Focus on the big alliance, not only the smaller ones within OPEC: The result highlights the importance for Saudi Arabia (and GCC allies) as well as Russia of retaining the alliance struck in 2016 on managing oil output. Remaining vague on the details of how the production will be re-allocated from Venezuela to the countries with spare capacity, avoids a political decision that will eventually need to be addressed, since its hard to see any meaningful increases from that country. In fact, output is likely to fall further due to strikes, job cuts and equipment seizures.
Gradualism allows for more information gathering: By later in the fall, there should be more clarity on the following relevant fundamental issues that make it currently difficult to plan.
- Iranian production and sanctions regime: Already, businesses (shipping companies, refiners and others) are chosing to pare their purchases of Iranian crude oil, looking to made some reductions that hedge their bets against U.S. requirements to significantly reduce purchases. These decisions reflect both concerns about sanctions implementation but also ongoing negotiations on price between Iran and its buyers. Details on how OFAC will implement waivers remain to be announced, suggesting that buyers are assuming continuity with the last administrations definition of “significant reductions” implying a 50% drop every six months.
- Other outages including continued implosion of the Venezuelan oil industry and broader economy as well as outages in Libya, Nigeria and elsewhere.
- Shale production and infrastructure: Rig counts, output and other metrics suggest oil production is increasing in the U.S. and will continue to do so. However, there continue to be bottlenecks getting the fuel to global markets (keeping the WTI and Brent spreads wide) and costs are increasing in the shale patch. The additions from the U.S. will be supportive of U.S. growth and the energy trade balance, but are unlikely to be enough to offset for other losses, particularly in the medium-term.
- Demand resilience in the face of higher than 2016/7 prices. Most assumptions posit continued oil demand growth due to resilient global demand and growth. Two factors increase the risk that the pace of demand growth will weaken – the increase in local cost of fuel to the end user in local currency and the risk of weaker global growth due to the moderation of the cyclical expansion, something that could be exacerbated by the increase in trade protectionism that is tempering the outlook for fixed investment. The composition of global growth, more linked to consumption (and thus transport fuels) provides some resilience to oil producers, but the pace of demand growth still may slow. By Q4, we should have a better sense if higher prices are tempering demand for fuel or other goods, making it easier to assess. Even before that individual countries may decide to pump more if key buyers (India, China among others) demand.
More data on each of these points will be key to the next phase of the alliance.
Exit from easing needs new forward guidance. 2018 was always going to be the year when the alliance shifted to a new phase. Like global central banks moving to quantitative tightening, the alliance (which was in a formal tightening phase), will employ new forward guidance for easing. The Joint monitoring committee (and a range of private monitoring bodies, are likely to take on a bigger role with focus moving beyond 5 year inventories as their main fundamental metric. It remains unclear what the new metrics, and forward guidance will look like. Saudi Arabian officials have already gone on the record to highlight the need for well over 1 million barrels a day in increase by the end of the year. Doing so, while absorbing Iranian output is likely to be difficult.
What might the impacts be on oil producers?
The decision brings increased breathing space to most oil producers, especially Saudi Arabia, most of the rest of the GCC and Russia, which account for the bulk of global spare capacity. While prices might soften from their recent levels, the increase in output, even if moderate should keep oil revenues elevated compared to 2017 levels and increase the energy contribution to growth. This should modestly reduce oil fiscal breakevens, though we assume that most countries will take the opportunity to spend a little more given that non-oil growth has been sluggish especially in MENA and SSA.
Our analysis suggests more GCC countries will use this space to become a little more expansive on the fiscal side, offsetting for what continues to be sluggish private sector growth, credit and sentiment. We have already seen stimulus rolled out in Abu Dhabi and Qatar, and spending outpace plans in Saudi Arabia, though some of these look temporary. We assume that fiscal breakeven price in Saudi Arabia may fall slightly to the low/mid 80s from the current $89/barrel, suggesting slightly less draw on debt. This implies that there will be more final demand rather than petrodollar savings. Countries in a position to save more include UAE (Abu Dhabi), Kuwait, Qatar, Russia, Kazakhstan, and possibly Nigeria. The chart below highlights likely shift in the current account surplus (flow of savings net of imports of goods and capital).
Other countries including Oman, Saudi Arabia, Iraq will likely tend to borrow less or draw down fewer reserves. Saudi Arabia likely will have more pump priming space to support the private sector.
We see a modest increase in Russian output, but limited impact on growth. In Russia, the flexibility of the exchange rate remains a key adjustment tool and increase in output is an offset to the financial cost of sanctions.
Those most vulnerable remain Venezuela, where local mismanagement, asset seizures and the exacerbating impact of sanctions suggest significant further outages. While politically OPEC could not formally reallocate its target, its hard to see any reversal of outages, especially as recent legal cases and strikes undermine its capacity further.
Iran, too will start to feel the pinch from the drop in oil prices, with the full impact dependent on sanctions implementation. For more on the scenarios, please see here. Decisions on adjusting to Iranian outages are more likely to be bilateral (between buyers and sellers) than within the alliance, but its hard to see if able to sell its current targets.
Ziemba Insights 