Here's an excerpt from an institutional research note written by Hedgeye Potomac Senior Energy Policy analyst Joe McMonigle. If you're an institutional investor email sales@hedgeye.com to read this entire research note.
The oil ministers of Saudi Arabia and Russia held a joint presser Monday on the sidelines of the Beijing summit to telegraph an agreement for a 9-month extension of the OPEC/non-OPEC production cuts of 1.8 million barrels a day.
While not official until OPEC members meet on May 25 to ratify the deal extension, we certainly expect this to be the outcome.
As we wrote in our May 8 note, OPEC needs to change the narrative of a persistent global oversupply. The market had already priced in an automatic 6-month extension of the deal. The normal course would have been to just rollover the agreement as expected and then re-assess at the year-end meeting if another extension was necessary.
But OPEC has a sentiment deficit and a 6-month extension would have resulted in almost no immediate impact on prices. OPEC believes a 9-month extension into 2018 will provide it with a sentiment surplus and so far the market likes the move.
Press reports have now quoted every OPEC minister as supporting the deal extension and the current price bump should ensure all members ratify the rollover to 9-months. Therefore, the OPEC component (1.2 M b/d) of the deal is assured.
However, general compliance and the non-OPEC component (600,000 b/d) led by Russia will provide some challenges to the deal. Russia will gladly go along for the ride but they have once again proven to be an unreliable partner. Russia pledged 300,000 b/d in cuts for the first six months of 2017 but only hit that full amount in May just weeks before the May 25 OPEC meeting. Russia’s lack of compliance is being glossed over because of OPEC’s need of a sentiment surplus. We expect Russia’s compliance to continue to be spotty at best.
Then there are other non-OPEC participants in the deal who present problems. Kazakhstan, which first revealed Saudi trial balloons of a 9-month extension in early May, has said recently that it cannot comply with the deal extension due to its expected higher production coming online this year.
We expect that there are efforts behind the scenes by the savvy and capable OPEC Secretary General to try to persuade the Kazakhs to make the pledge again and at least try to meet compliance. If not, OPEC is already trying to find additional non-OPEC producers who would join the deal to mitigate any fallout caused by Kazakhstan or other producers. The focus seems to be on Egypt and Turkmenistan but is all about sentiment with little real impact on the math.
