view on OPEC’s desicision

Saturday’s OPEC+ press conference provided more clarity on the decision to increase production, with guidance for a full 1 mb/d ramp-up in 2H18. This is a larger increase than presented Friday although the goal remains to stabilize inventories, not generate a surplus, which is consistent with our base case forecast. Yet we also learned on Friday that the outage at Syncrude Canada’s oil sands facility could leave North America short of 360 kb/d of supply for all of July, putting Cushing potentially on a path to an inventory stockout. With the global market pricing to pull crude out of the US, this loss of US supplies will exacerbate the current global deficit, making the increase in OPEC production all the more required. And while Saudi is already ramping up exports, these will not be delivered until August with June stock draws already accelerating.

This sets the stage for a large divergence between prompt and forward balances, with the former likely to see large stock draws and the latter pointing to a balanced market later this year. Saturday’s OPEC press conference may weigh on Brent prices and deferred timespreads early this week if the market focuses on the 1 mb/d headline. For example, if the market interprets Saturday’s announcement as a 300 kb/d increase in production over six months relative to Friday, our pricing model would point to a $3/bbl negative impact on Brent prices. Yet, nearby Brent timespreads will likely continue to strengthen given the greater spot deficit. In our view, the reality of today’s deficit will likely prevail and we reiterate our summer $82.5/bbl Brent price forecast. The greater clarity on a large increase in OPEC+ production has reduced the upside risk to our price forecast in 2H18, nonetheless, and our base case remains that Brent prices will sequentially decline to $75/bbl by year-end. We continue to believe, however, that it is premature to position for this move lower given the current shortfall and low level of inventories. In fact, the recent pick-up in outages (Libya, Nigeria, Canada) and the growing risks that Iran production falls even more than we had expected may end-up challenging OPEC’s immediate spare capacity.

The press conference held Saturday after the OPEC+ meeting proved more specific than Friday’s, with participation from both the Saudi and Russian oil ministers. The message delivered was the same, ie to return to full compliance to the initial quotas but both ministers stated that this would represent a 1 mb/d effective increase, not the 0.7 mb/d floated the previous day (the logic behind the 1 mb/d remains less clear, since the IEA May data only points to a May shortfall of 0.5 mb/d for the 24 participating countries). Several countries including Iran and Iraq rebutted the 1.0 mb/d increase quickly after the conference but since the rise will be driven by core-OPEC and Russia, only their view matters at this point. Such disagreements, however, reinforce our view that this OPEC meeting likely started the disintegration of the broad production cooperation effort.

Ultimately, global oil supply and demand are volatile and the global deficit may still be much larger than currently estimated given the large 0.8 mb/d IEA miscellaneous to balance. So what is behind the decision to increase production? As explicitly stated by the Saudi energy minister, it is one of balancing the market, not to target a surplus. The decision to balance the market itself reflects a response to consumers’ request to stop the appreciation in prices, namely India, China and the US. We therefore continue to believe that the core OPEC and Russia production increase will target higher output, stable inventories and not a sharp fall in prices. In the case of Saudi, supporting prices helps fund its economic diversification and maximize the value of the assets it is selling while higher production prevents high prices that would hurt consuming nations that either provide it with security or will be important in its economic transition (US, China, India). In the case of Russia, collaboration with Saudi increases its sphere of influence although the country no longer benefits from rising prices: the state saves excess oil revenues in foreign assets leaving for little impact on current activity while rising domestic fuel prices are keeping the CBR more hawkish.

We recently forcast oil supply-demand balance featured a combined increase in total OPEC and Russia/Oman production of 550 kb/d in 3Q18, which still appears a likely outcome given: (1) the 620 kb/d increase in core-OPEC, Russia and Oman production that it reflects, a figure consistent with a “gradual” ramp-up in our view, and (2) the partly offsetting 200 kb/d declines in Venezuela and Iran production that we expect in the quarter. By 4Q18, we had expected core-OPEC and Russia/Oman production to be up 1.0 mb/d vs. May-18 levels, although a further sequential increase in disruptions of 0.48 mb/d left total OPEC+ production up only 0.53 mb/d vs. May levels. Importantly though, it left the global market only 0.1 mb/d in deficit. As a result, the motivation of Saudi and Russia to grow production and the volumes needed to be brought online to balance the market (ie 1.0 mb/d) suggest that our base case forecasts are still valid.

While  all eyes were on Vienna on Friday and Saturday, a much more dramatic development took place in North America, with WTI prices rallying by $3.05/bbl vs. Brent over Wednesday-Friday and most strikingly, WTI cash basis rallying to its highest level in four years at $2.85/bbl and front-month WTI timespreads reaching $0.95/bbl. This move was triggered by an outage at the 360 kb/d Syncrude Canada oil sands facility due to a transformer blast that cut power to the plant, which already faced several reliability issues in recent years.