Commodities Corner: Expectations grow for deeper oil production cuts by OPEC and its allies

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The Organization of the Petroleum Exporting Countries and their allies, collectively known as OPEC+, will meet later this week as speculation grows that the oil producers may increase the size of crude output cuts already in place.

The latest news development, however, conflicts with a Bloomberg report Friday that indicated Saudi Arabia may not be willing to compensate for excessive production by other OPEC members.

“While the Saudis are surely unhappy that other OPEC nations are overproducing their quotas,” and with the fact that oil prices are trading $60 a barrel and not $70 or $80 a barrel, “they have too much invested at this stage to change course,” Ryan Fitzmaurice, energy strategist at Rabobank, told MarketWatch on Monday.

OPEC+ will consider deepening existing oil production cuts by about 400,000 barrels per day to 1.6 million barrels per day, Thamer Ghadhban, Iraq’s oil minister, told reporters in Baghdad, according to a report from Reuters Sunday. The current OPEC+ agreement calls for an output cut of 1.2 million barrels a day from late 2018 levels through March 2020.

Members of OPEC have scheduled a meeting for Thursday, and will hold a separate gathering with allied non-OPEC members on Friday in Vienna.

OPEC+ knows that “the market will punish them if they choose to loosen the current agreement in any fashion,” Fitzmaurice said, pointing out that the news Friday that the Saudis were considering increasing their production unless other members produce in line with the agreement sent WTI oil prices down by over 5%.

On Monday, the market has seen the “reverse happen and oil prices are recovering some of Friday’s losses” following news that producers are considering deeper output reductions, he said.

“We continue to expect a volatile week ahead with contradicting OPEC headlines,” he added.

Read: Here are the biggest risks to OPEC+ efforts to balance oil

On Monday, global benchmark Brent crude futures UK:BRNF20  traded at $61.28 a barrel on the ICE Futures Europe exchange, up 79 cents, or 1.3%. U.S. benchmark January West Texas Intermediate crude CLF20, +1.40% rose 96 cents, or 1.7%, to $56.13 a barrel on the New York Mercantile Exchange. Year to date, the front-month Brent contract trades up by around 14%, while WTI has gained 24%, according to FactSet data.

Fitzmaurice believes there is “very little incentive” for the Saudis to increase production.

“The market signal is clear and so is math,” he said, pointing out that the Saudis produce roughly 10 million barrels a day and at $60 a barrel, for $600 million a day in revenue.

So, if the Saudis were to increase production by 500,000 barrels per day, the market would expect to see at least a $5 a barrel sell off in oil prices, if not more, he explained. This would result in roughly $25 million a bay less revenue “despite the higher production, so there is very little incentive to do that — especially considering that the Saudi Aramco IPO has recently been given the green light.”

“As such, our base case is for the current agreement to be rolled forward with stricter adherence and controls with respect to Russia, Iraq, Nigeria, and Libya,” said Fitzmaurice.

And if these nations start producing to their current quota levels, that would in effect be a 400,000 barrel per day cut, the size of which is “currently being floated and enough to balance the market in our view,” he said.

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