Below we expand on a note written this morning by Hedgeye energy policy analyst Joe McMonigle. Ping your sales contact or for access to the team’s work.
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The constant newsiness and lack of credibility around a speculated production freeze has been well covered by our energy policy analyst, Joe McMonigle. Below we raise two important points with regard to a quota revision in the near-term:
- First, a topic we’ve harped on before - OPEC quotas have had no bearing on actual production levels historically – the only impact has been a short-term spot price impact.
- The fundamental story at play is one that questions the timing of a speculated revision in quotas – why now for OPEC as they’re winning the global market share game for the first time in a long time? Saudi Arabia has alluded to U.S. Shale being a barometer for forward-looking policy.
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We have long been skeptical of OPEC’s desire to actually cut production. In a note before the double digit post-Thanksgiving decline for WTI in 2014 we highlighted a notable analysis on OPEC’s still meaningful aura along with the lack of incentive for a cut: OPEC Cut? Nope.
- OPEC announcements have an ability to move spot prices for about 15-20 days, but there is no evidence that production levels are at all influenced
- The correlation between OPEC quotas and oil prices is non-existent (r^2 =.15 since inception in 1982 according to the study)
- During this period all OPEC nations except Iran and Venezuela over-produced 80% of the time based on monthly observations
- The nine principal OPEC members produced on average 10% above their respective quotas in this period from 1
- In the same period there were 22 OPEC meetings where quotas were increased, and in 21 cases, the increase in quotas were still below what each country had produced the month before quotas were raised
Source: “The Emperor Has No Clothes: The Limits of OPEC in the Global Oil Market” – Jeff Colgan
We continue to maintain the stance that OPEC members are concerned with market share and influence with an emphasis on driving other producers out of the market over per unit pricing – Actions from the most influential OPEC members support this view, and fundamental data suggests this strategy has worked, something we’ll get into below.
As we outlined in this morning’s energy policy note:
- The goal for OPEC is a production ceiling but the “how” remains a difficult challenge. It is the reason why a freeze deal was not achieved this week.
- OPEC went with the newsy headline because they were faced with the prospects of price decline for not meeting self-imposed expectations of a freeze accord, another case of groupthink trying to manage expectations it has created
- The 32.5 million b/d ceiling number that was selected for the statement represents OPEC’s own forecast demand for its crude in 2017.
All things considered, we believe the path out of Algiers is on thin ice and provide the following rationale - we are not optimistic about the prospects of successful collaboration.
Taking a closer looks at the OPEC statement raises skepticism on a deal…
For one, the OPEC President told reporters at a press conference Wednesday that the start date and duration of the revised production target are yet to be decided (maybe Jan. 1st), but Iraq has said recently that it can only agree to a duration period of several months. After the Algiers meeting ended, the Iraq oil minister questioned OPEC's own production data to determine baselines under any revised production target. "These figures do not represent our actual production," he told Reuters. "We cannot accept this and will ask for alternatives." Even the “target” is a moving target.
We also question why OPEC would agree to a cut now before a growing amount of non-OPEC production comes offline – a trend that is now finally in the works, greatly lagging expectations in 2H of 2014 when the U.S. dollar began its breakout. The benefit of a market share over price strategy appears to be accelerating. The largest OPEC countries continue to outlast U.S. Shale
- OPEC production on the whole is +3.4% Y/Y, driven largely by Iran. A ratio series of OPEC to U.S. production has been running +10% Y/Y for the balance of 2016
- US crude production today is about 600-700K B/D less than one year ago and down ~1MM B/D from the June 2015 peak. New Iranian production this year since nuclear sanctions were lifted has just replaced the declines in US production. If prices rise above $50/barrel, U.S. shale producers may end up replacing any OPEC decline from a production ceiling
- Production in Saudi, Iran, Iraq, U.A.E. (the top 4 OPEC producers) is +3.6%, +8.3%, +28.9%, +4.2% respectively Y/Y
As we wrote in May to the energy policy vertical before the June meeting, we noted that the upcoming November 30 meeting could be the first time in two years that a change in OPEC and Saudi production policy would be under serious consideration. In particular, we said declining US production was a key barometer for the Saudis as well as continued cap-ex cuts. Since early summer, Saudi Energy Minister al-Filah has expressed that the Kingdom sees evidence the market is slowly coming into balance.
We know the early return of US shale production is a significant concern to the Saudis, but they also believe that it will take at least a year for US producers to regain previous levels and assume demand will also be higher in turn.
Certainly market conditions could change between now and November 30. Plus we do not believe the Saudis will want to forfeit any market share to Iran.
As a result many thorny issues lie ahead that present real challenges to achieving a revised “production target” in November.
As always, please reach out to us with comments or questions.
