Editor's Note: OPEC will meet informally on September 26-28 on the sidelines of the International Energy Forum in Algeria spurring speculation that a production freeze may be under consideration to stabilize prices. The following is an excerpt from an in-depth client note sent this morning. To see the full note and all five reasons not to expect an OPEC production freeze later this month, please contact email@example.com.
1. For Saudi Arabia, it’s too soon for a production freeze. The market is still oversupplied with record crude inventories. Therefore, in the Saudi’s view, more cap-ex cuts and production declines are needed to bring the market into balance, otherwise the last two years of pain - costing the Saudi’s about $100 billion a year - were for naught.
In 2014 when the Saudi’s declined to intervene with production cuts to limit the price slide, the market share strategy was launched. Saudi Arabia realizes they are no longer the only actors affecting oil markets, especially in light of surging US shale production. If the Saudi’s cut production to stabilize prices, they lose market share.
The strategy called for a period of low prices that would force production declines in high cost production (shale & off-shore mega projects). After one year, the Saudi’s, and most everyone else for that matter, were surprised at the resiliency of US shale. So the Saudi’s were determined to ride out another year of low prices to starve non-OPEC production. What followed were cap-ex cuts two years in a row and a steady decline in US production. According to the IEA, global cap-ex cuts since 2015 are now at $330 billion, and Wood Mackenzie further estimates cap-ex cuts in global upstream of nearly $1 trillion out to 2020. Meanwhile, US production has steadily declined about one million b/d from a high of 9.5 million b/d n April 2015.
But crude stocks are still at record levels – a stark reality that is putting a damper on the market-is-balancing party. The most recent EIA data for the week ending September 9 reported crude stocks were at 510.8 million barrels - up 55 million barrels this year and 100 million barrels above the five-year average.
The Saudi market share strategy has worked. The IEA said this week that Saudi Arabia has ousted the US as the world’s top producer. So the last thing the Saudi’s want to do now is to put the brakes on a strategy that is working for them. A production freeze that boost prices will only encourage more US production.
As we have seen this summer, price signals near $50 have slowed declining production. Just this week, the IEA changed its previous forecast that the market was balancing at year-end and now says non-OPEC production will rise in the first half of 2017. Rising non-OPEC production is anti-freeze to the Saudi’s. Another nail in the coffin of a production freeze later this month.
So a freeze now would just throw a lifeline to US shale. In our view it is still too soon for any change in OPEC production policy. Saudi Arabia is more nervous about oil at $50 than $40 because they know it keeps US shale alive. The barometer for any new change in OPEC production policy is declining US production, and Saudi Arabia wants to see more of it.