OPEC meeting puts oil at the crossroads with another production cut the likely direction
Straddling the “death cross” and “golden cross” – that’s where the oil market is delicately poised at the moment.
Ahead of OPEC’s ministerial meeting in Vienna on Thursday evening, called to discuss extending production cuts to support prices, oil is very much at the crossroads.
Five months into the original deal, brokered by OPEC’s dominant player Saudi Arabia with support of the non-OPEC giant Russia, supplies have not been curtailed that much and prices have fallen around 5 per cent.
But that does not mean it has been a failure. In fact, things could have been much worse for the producers.
The previous strategy of pumping US producers into submission would have seen prices much lower.
That would have been very painful for oil-centric economies that need oil to be $US100 a barrel on average to balance their budgets, according to recent research from the investment banks RBC.
At current prices Russia is treading fiscal water, with its budget balance predicated on an oil price of around $US50 a barrel.
For the Saudis, with their massive defence budget, which just got bigger, the price is closer to $US130 billion.
In Libya, $US200 a barrel would do the trick, but would about as likely as Disney deciding to build a theme park there at the moment.
Extending the production cuts most likely outcome
There are three possible outcomes from the meeting.
The most likely is simply to extend the expiry date of the cuts, from the end of June, by either six or nine months.
There is also a chance the deal could be extended and the cuts deepened, but that is far less likely, around a 10 per cent chance according to market analysts.
Then there is the collapse in talks, “no extension” option, the one Saudi Arabia will doing its best to avoid.
Already the short term price is converging with the long term price, which has made this meeting the fulcrum of the immediate future of oil’s fortunes.
No extension to the deal to the deal would see the spot price tank, falling probably around $US5-to-$US10 barrel, creating what the technical chartists, who watch this sort thing, call a “death cross”‘
As the name suggests, this would be very bad news for producers and by extension, good news for motorists.
Extending the current deal has, to a large part, been priced in.
It would most likely see a modest relief rally in prices, or minor grief rally for motorists and other consumers.
Extending the deal, and cutting deeper into production, could see prices bounce back up from the long term trend – the “golden cross” scenario – perhaps gaining around 10 per cent, or $US5 a barrel.
How long can the Saudis hold the deal together?
But it is not likely to be as simple as the binary – bear versus bull – outcome viewed by the chart analysing brigade.
The deal has only held, at around 97 per cent compliance of the 1.8 million barrel a day (mb/d) cut originally planned, due the Saudis going well beyond the call of duty.
Figures from industry analyst Petro-Logistics indicate the Saudis – the biggest OPEC producer by far – have cut production by 553,000 barrels a day, about 14 per cent higher than their part of the deal.
As well, planned maintenance shut downs though the gulf states of the UAE, Kuwait and Qatar over the past six months helped, but won’t be repeated this time around.
The OPEC side of the bargain is already under pressure with Libyan production up more than 60 per cent since the deal was struck, delivering an extra 320,000 b/d, while repairs to a sabotaged Nigeran pipeline could flood an additional 200,000 b/d onto the market.
The non-OPEC nations, marshalled by Russia – which produces even more oil than the Saudis – were supposed to deliver cuts of around 400,000 b/d.
Russia hasn’t exactly rushed out an embraced the cuts, but still has chipped in, unlike the Kazakhs and most other producers outside the OPEC orbit.
US production is putting pressure on the deal
Then there are the US producers who have been pumping furiously – production is up by 10 per cent over the year.
Capacity is increasing all the time too, with number of rigs in the shale oil fields up pretty well every week since the cuts – not endorsed by the US – were implemented at the start of the year.
Worryingly for the Saudis, the production cost for “tight oil” is $US35 a barrel and falling. Continuing to pump them them below the marginal cost of production would be catastrophic for everyone but consumers.
As well, the US isn’t going to run dry any time soon.
The Wolfcamp formation alone, in the Permian Basin of Texas, is said to have reserves of around 20 billion barrels, second only in size to the pride of Saudi Arabia, the massive Ghawar field.
Saudis need oil price higher to escape oil dependency
While the Saudis are not exactly financially strapped, they are staking their economic future, and plans to extricate themselves from an oil dependency, on keeping the price oil above $US60 a barrel.
Currently the Saudi capital of Riyadh is awash with investment bankers working on the “sale of the century”, the partial float of of the mammoth state-owned Saudi Aramco oil business.
The Saudis are looking to flog off a 5 per cent chunk of the enterprise they value at $US2 trillion – in quantum, somewhere between the GDP of India and Italy, and well above Australia’s $US1.2 trillion.
While many in the market argue it is worth half that – particularly given the current supply/demand dynamics – between $US50 and $US100 billion in cash is plenty of incentive to keep the price up until at least the Aramco float, expected sometime next year.
An increase in global demand would help the Saudi case, but such a move looks to be only tepid at best.
The International Energy Agency’s latest bet is the massive oil glut swamping global markets might start draining later this year.
However the IEA left its forecast for demand growth unchanged and noted “much work remains” to drain the build up in stocks that has seen oil prices halve since 2014.
A six month extension of the cuts, with another review at the end of year, is the most likely outcome.
But that won’t change the long term momentum of the ebbing tide of oil demand.
As the need to sell off its one big asset accelerates, the Saudis may learn the harsh distinction between being a price setter and price taker.