Overnight in Algiers, OPEC (Organization for Petroleum Exporting Countries) announced the agreement of a framework for members to restrain oil production to 32.5-33 million barrels a day – the first time since the financial crisis of 2008 the group has agreed to cut production. That would represent an average reduction in output of about 700,000 barrels a day.
The initial reaction from the oil market has been significant, with Brent and WTI (West Texas Intermediate – a grade of crude oil used as a benchmark in oil pricing) rising 6%[1] following the announcement, reflecting prior consensus that OPEC would instead continue to be at loggerheads.
OPEC is yet to release precise details of the agreement, but a working group has been formed to thrash out the terms of the deal in time for the next formal meeting at the end of November.
Intuitively, we remain sceptical that OPEC will deliver real production cuts. It is worth pointing out this is only an agreement in principle thus far, which is a long way from securing formal cooperation from all members, let alone from enforcing discipline.
As I discussed in a blog post last month, OPEC’s history of success as a cartel has been very limited, especially since 1980, with members regularly cheating on quotas, and the quotas themselves being abandoned (officially in 2015 and unofficially in 2012) owing to the lack of cooperation.
OPEC is most effective when either it, or the oil market, is in dire straits – for example the production cuts of 4.2 million barrels per day during the financial crisis of 2008/9. It does not feel that either is currently in a desperate situation, though there are clear pressures on OPEC government budgets, and Saudi Arabia has had to delay its first international bond issue. Like many oil companies, OPEC government budgets inflated rapidly during the last upcycle for oil and have been deflating accordingly – witness Saudi Arabia’s announcement just a few days ago that it would be cutting ministers’ salaries and reducing public sector bonuses.
Our initial thoughts are that this announcement could be beneficial for some. For example, US onshore producers, with their aggressive cost-cutting and short-cycle investment horizons, have ideal attributes for increasing production in response to higher prices.
This announcement brings bullish headlines for the oil price, probably underpinning the low end of the recent trading range, and perhaps even pushing that low end up by a few dollars. Nevertheless, the underlying supply backdrop offers a headwind to oil market rebalancing before 2018/19 unless OPEC regains its effectiveness. Many major project start-ups are either underway or imminent, following a multitude of FIDs (final investment decisions) taken two to five years ago, which is likely to keep supply buoyant and restrain prices.
[1] Source: Bloomberg
Authors
Duncan Bulgin
Portfolio manager, Global Opportunities team
Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that holdings and positioning are subject to change without notice.
Comments