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Takeaway: We forecast an OPEC production cut of 1.066Mb/d with return of high over-compliance in 2019 - plus 2018 supply losses from Iran & Venezuela.

Summary:

  • Oil markets are focused on an "oversupply" narrative that, from a fundamentals view, is sending prices lower. 
  • The JMMC meeting played out exactly as we wrote in a client note: much talk about cuts but no specifics leaving the market disappointed. 
  • But hard numbers of actual cuts to supply are coming, and the high tide of oil supply is receding.
  • We forecast OPEC+ will extend cuts into 2019 at December meeting and go back to April "over-compliance" levels of 152% that translates into a cut of 1.066M b/d (OPEC compliance in October was 104%).
  • Saudi Arabia said it would cut December production by 500,000 b/d but we think the Saudis are already cutting and November data will show a surprise cut just as OPEC meets on Dec 6.
  • Despite all the talk about waivers and no zero exports, Iran exports will be cut by 1.1M b/d in November and 1.3M b/d in January. No one thought Iran was going to zero exports. When we forecasted last year that Iran sanctions would cut 1M b/d, it was dismissed as too high.
  • Venezuela production has declined about 740,000 b/d this year. We expect another loss of 100,000 b/d for total loss of Venezuela barrels of 840,000 b/d in 2018 and considerable risk going into 2019.
  • EIA and IEA both forecast oil demand growth in 2019 of 1.4M b/d. While non-OPEC production is widely expected to increase (led by the US) in 2019, EIA's latest Short Term Energy Outlook forecasts supply and demand to be in balance next year.

Oil prices retreated sharply this week after OPEC’s Joint Ministerial Monitoring Committee (JMMC) Sunday meeting in Abu Dhabi failed to give the market specifics of planned production cuts to blunt downward momentum in prices. Saudi Arabia said it would cut production by 500,000 barrels per day (b/d) in December but JMMC co-chair Russia sent mixed messages about the path forward.

With oil prices down by $16 as the JMMC meeting was underway, the market was practically begging the OPEC committee to take decisive action. The market wants hard numbers but the JMMC is not designed to make changes in production outside of a meeting of the full OPEC conference. 

Certainly, there are other macroeconomic factors influencing prices, including the strong dollar as well as concerns about trade and emerging markets. But from an oil fundamentals view, we believe markets are largely focused on oversupply. 

We believe the high tide of oil supply is receding, and the hard numbers of actual production cuts that the market seeks could come even before the December 6 OPEC meeting in Vienna. We forecast an OPEC production cut of 1.066Mb/d with a return of high over-compliance levels in 2019 - plus 2018 supply losses from Iran sanctions (1.1Mb/d) and Venezuela (850Kb/d). As a result, we see oil prices recovering by year-end.  

Here are some key developments we see ahead for the oil supply equation.

Big picture – production cuts extension into 2019. The big picture for investors has not changed: OPEC is setting the stage to extend the production cut deal into 2019.  The pact with Russia and other non-OPEC producers is currently scheduled to expire at the end of the year. While we don’t expect a change in the deal’s output ceiling, we believe OPEC will revert back to “over-compliance” or deeper cuts from current levels. The JMMC said October compliance was 104% but we believe “over-compliance” may increase as high as the 152% level reached in April 2018 and lead to a production cut of about 1.066 million b/d.

Russia will be on board with rollover of cuts. Russia sent mixed messages at the JMMC meeting about its willingness to extend cuts in 2019. Russia’s energy minister Alexander Novak met with oil company executives last Thursday ahead of the JMMC meeting. We believe Russia wants to allow its oil companies to continue with higher production levels through the rest of the year but will ultimately join the Saudi-led initiative.

Saudi Arabia is likely already cutting production. Saudi oil minister Khalid al-Falih said Sunday that the kingdom would cut December production by 500,000 b/d but we believe it is already cutting production in November. Similarly, at the June 23 OPEC meeting when the JMMC decided to boost production (by reducing over-compliance), Minister al-Falih announced that Aramco had already been boosting production since early June. Indeed the Saudis hiked production by nearly 500,000 b/d in June – three weeks before the official OPEC decision to increase production on June 23. We see the same scenario playing out but this time it will be evidence of production cuts in November just as the December 6 OPEC meeting in Vienna gets underway. As we have written in recent notes over the past few weeks, we believe the Saudis are taking their foot off the “Pump for Trump” gas pedal after the election. We see Saudi Arabia production declining early next year to Q1 2018 levels of about 10 million b/d and translate into a cut of about 600,000 b/d from October.

The High Tide of Oil Supply is Receding - saudi production and oil prices 

Iran sanctions = 1.1 million b/d cut in November. The oil market’s word association game goes like this: “sanctions” > “waiver” > “oversupply.” But this is a simple analysis based on headlines. The reality is the US sanctions will remove 1.1 million b/d of Iranian oil from the market in November (from a May baseline). Three of the eight “waivers” will terminate in January thereby increasing cuts in Iran exports to 1.3 million b/d and likely rising from there.  These numbers are based on our Hedgeye forecast for Iran exports that you can review here. No one thought Iran was going to zero exports. When we forecasted last year that Iran sanctions would be cut by 1 million b/d, it was dismissed as too high. We talked to one tanker tracker analyst Wednesday who told us that there have been very few Iran departures (of tanker exports) so far this month. But soon the market will see real hard numbers on Iran exports for November and be able to judge if “sanctions” = “cuts.”

OPEC will unfollow Trump tweets on oil prices. In his post-election press conference, President Trump claimed responsibility for lower oil prices ahead of the election. We think he was half right. In our view, he was certainly responsible for pressuring Saudi Arabia and other gulf producers to boost production ahead of the US election. The other part of the equation was larger-than-normal refinery maintenance in the US that resulted in weekly stock increases in EIA data over the last several weeks. The increases in US crude inventories are a large contributing factor in the oversupply narrative and the recent price decline. In our view, the Saudis and other producers believe they kept up their side of the deal to help Trump ahead of the election but now are looking out for their own interests with regard to production. So we think the President’s oil tweets will be less effective than before. However, oil markets still react to Trump’s tweets as we saw on Monday. We think this stems again from the misinterpretation of Iran sanction waivers and the mistaken belief that Trump may further weaken sanctions if oil prices rise. But we see additional or weakening waivers as undermining Trump’s Iran policy and highly unlikely.

Venezuela production will decrease 840,000 b/d in 2018. OPEC’s Presidency will transfer in 2019 to a new country/member based on alphabetical order. This means that Venezuela will become OPEC’s President in 2019 after the UAE’s term ends at the end of this year. Venezuela has involuntarily led OPEC's production cuts this year with production sharply down by 740,000 b/d based on OPEC’s secondary sources of production for October. Venezuela loses about 50,000 b/d per month so we estimate its production will be cut by 840,000 b/d in 2018.  

EIA forecasts 2019 supply and demand to be in balance. We agree that there will likely be stock builds in the first half of 2019 but we think it will be much lower than expected with our forecasted OPEC cut of 1 million b/d. Moreover, EIA and IEA both forecast oil demand growth in 2019 of 1.4 million b/d. While non-OPEC production is widely expected to increase (led by the US) in 2019, EIA's latest Short Term Energy Outlook forecasts supply and demand to be in balance next year.

The High Tide of Oil Supply is Receding - EIA 2019 supply demand balance