The bureaucrats of the oil cartel have delivered their latest crowdsourced judgement.
The top line? The agreement will add around 0.6m b/day of production from OPEC to the market. In country terms, most of that increase will probably come from Saudi, Kuwait, Iraq and the UAE. Against that it’s worth noting there are significant OPEC supply risks in the second half of 2018 with further supply disruptions from Venezuela, Iran and Libya each capable of offsetting today’s OPEC production increase. Overall OPEC remains committed to delivering a reasonable oil price to satisfy their own economies but also to incentivise investment in long-term projects.
Here are the main declarations from the oil potentates in Vienna.
On the oil market recovery “Since the last Meeting of the Conference in late November 2017, the oil market situation has further improved. The global economy is strong, oil demand remains robust, the market is evidently rebalancing, and the return of more stability has been welcomed by all stakeholders.”
On providing stability and guardianship “Our focus today is on reviewing all the market fundamentals to help better understand the market balance and stability we all desire, in the interests of producers, consumers and the global economy. We fully appreciate and take on board the viewpoints and concerns of all industry stakeholders. We are watchful, responsive and fully committed to market stability and global energy security…. we need to continue to tread carefully; none of us want to see the return of the kind of volatility that allows pessimism to return to the markets”
On future investments to ensure a balanced market “So far in 2018, the pace of investment has gradually picked up, but we are still not seeing enough robust investment in long-cycle projects. To put this into some perspective, in the period to 2040, the required global oil sector investment in OPEC’s World Oil Outlook is estimated to be $10.5 trillion, with oil demand set to surpass 111 million barrels a day by 2040…It is also important to remember that investments are not only about boosting new production. Oil producers also need to account for natural decline rates…Every effort should be made to avoid a potential supply gap that could present a future serious challenge.”
What should we make of these gnomic prognostications from an investor point of view? I tend to defer to the experts at Guinness (who have a very successful global energy fund) who’ve been watching this space for aeons. Here’s their take….
“We continue to think that Saudi are managing the oil price in a rational fashion. On the one hand, the IMF still forecasting Saudi requiring oil price of $70+ /bl in 2018 in order to close their fiscal deficit to zero. An IPO or private sale of 5% of Saudi Aramco is also still planned: we estimate that the targeted $100bn proceeds can only be achieved at an assumed long-term oil price of $70. These factors underpin Saudi’s efforts over the last twelve months to bring Brent back above $70/bl. However, Saudi are also well aware of the risks of over-stimulating non-OPEC supply (especially shorter cycle US shale oil), whilst also the dangers to oil demand growth posed by too sharp an oil price increase. An increase in OPEC production is therefore logical, and we see it in the interests of energy investors, who we think are best served by a flattening of the oil curve: near-term oil prices stabilising to ensure that there is no oil shock to the world economy, whilst longer dated oil prices firm up, in recognition of the supply challenges caused by chronic underinvestment in non-OPEC outside the US. Overall, we believe that Saudi/OPEC’s long-term objective remains to maintain a ‘good’ oil price, higher than the current oil futures curve is indicating, and managing the unwinding of OPEC’s production quotas is another step on that journey”.
I also tend to take notice of the energy team at Westbeck who’ve been running an energy fund for the last few years. Like Guinness they are obviously bullish energy and energy equities but their analysis is usually very objective and informed. In their latest note to investors they think that oil could now hit $100 – echoing the views of a number of well informed market players. As I’ve said before, I’m not as bullish but heres Westbeck’s most recent take on the oil markets….
We expect oil prices to resume their move higher over the summer forcing President Trump to release SPR in September ahead of the mid-terms.
The President has some flexibility to establish the needs for a ‘limited drawdown’. However, we see this as limited to 30mb for no more than 60 days. In other words, in our view it is unlikely SPR would be released before September and would have to be bought back right after the elections. SPR can be released as fast as 4mbd, i.e. 30mb could be released in ~8 days.
Timing, however, would coincide with fall maintenance season for US refiners. This in turn could max out US crude oil exports. Meaning a crude oil release in the US might remain landlocked, affecting WTI pricing but doing nothing to appease international prices and hence US domestic gasoline prices.
How to play this? Oil equities and back-end of the oil curve:
The risk of SPR release makes positioning at the front of the oil curve difficult. Lack of spare capacity + need to buy SPR back + current backwardation makes the back end (Cal 19 and Cal 20) very attractive in our view.
We also believe equity investors are due for a rude awakening as all the dynamics above start to play out.
We expect huge sector rotation in oil equities over the next 6 months.
Spike seems almost unavoidable to us come 2019:
We believe lack of inventories & spare capacity mean oil demand in 2019 will need to be rationed by much higher prices.
It will likely be a disruptive process for the world economy in our view, compounded by IMO changes.
We expect a spike similar to what happened in 2008 and for the same reasons – but that this time around the drivers for a spike are even more powerful.
The health of the global economy will dictate how high we go. Fiscal stimulus in the US and ECB rate commitment suggest the economy could be fairly resilient to higher oil prices next year: in our view new all-time highs are entirely possible if not probable.
But I’m going to finish with a sting in the tail. A note out earlier this week from Global Data contained a standout number that I think is worth repeating again and again. OPEC may want oil prices to stay high to pay for their welfare programmes but over in America, high oil prices might translate into bumper profits – especially in the super-lucrative Permian basin. A report out on Monday from Global Data suggests that “ an analysis of recent wells for 26 operators in the Permian basin indicates a break-even oil price range from US$21 to US$48 per barrel with lateral lengths ranging from 4,500 ft to 10,500 ft.” The chart below fleshes out the story. The bottom line? Bumper profits beckon for the US shale industry as OPEC keeps prices too high. My portfolio implication – I’m still very bullish on Riverstone Energy.