Market Loves the OPEC Deal But Many Reasons To Be Wary
OPEC produced a deal but now let’s see if they can produce the cuts.
In the meantime, oil prices are hitting record levels after the weekend’s meeting between OPEC and Non-OPEC ministers that resulted in a creative agreement to cut 558,000 barrels per day (b/d).
As we said in our November 30 note, there was never any doubt there would be a non-OPEC deal since OPEC made its own cuts contingent on it. But we view the non-OPEC deal as the weak link in OPEC’s decision to manage sentiment.
First, OPEC said on November 30 that it received pledges of 600,000 b/d in non-OPEC cuts with Russia contributing half at about 300,000 b/d. But the non-OPEC number announced Saturday was just 558,000 b/d and the entire amount is on shaky ground.
Russia said it would “gradually” get up to 300,000 b/d which is code for cheating. Kazakhstan’s minister said today that it’s 20,000 b/d cut was “symbolic” and there is no limits on its new Kashagan or Tengiz production growth. Mexico and Azerbaijan both say their cuts under the deal will result from “natural declines” in production.
Second, unlike the November 30 agreement where OPEC released a detailed accounting of specific cuts and production allotments for each OPEC member, there was no such release of specific numbers for each non-OPEC producer. Instead, OPEC just announced the 558,000 b/d overall number. In Washington, this would be called creative accounting.
The Russia-pledged cuts are the most suspect in the entire deal. Russia doesn’t have a very good track record of compliance with previous production agreements with OPEC. In fact, their track record is cheating and no compliance.
Moreover, even if Russia wants to comply, there are many logistical hurdles to compliance. Unlike Saudi Arabia where there is a button in a control room in Dhahran, Russian companies would have to manually shut down production at wells in far flung places in the country in the middle of winter. Plus its energy companies are public companies with western partners that are not easily susceptible to command and control production directives from the government. Thus the best the Russian minister could do is to say it will comply “gradually.” We expect to soon hear about “technical” reasons why they cannot comply.
In our view, the rest of the non-OPEC cuts are smoke and mirrors, and most producers have no intention of keeping to the cuts. Higher prices will encourage cheating.
Saudi Arabia knows the market would be very skeptical about the shaky non-OPEC deal so that is why Minister Al-Falih dropped the news on Saturday that Saudi Arabia may decrease production even below the ceiling it agreed to on November 30 as part of the OPEC deal. This Saudi comment is the real reason why oil prices surged today.
Certainly, the Saudis and other Gulf commitments (UAE, Kuwait, Qatar) to cut about 786,000 b/d are real. But more than half of the 1.8 M b/d cut is suspect, and we expect we will start to see signs of wide-spread non-compliance early next year.
EDITOR'S NOTE
This is an excerpt from an institutional research note written by Hedgeye Senior Energy Policy analyst Joseph McMonigle. To read the full note, please contact sales@hedgeye.com.
