OPEC’s Joint Ministerial Monitoring Committee is meeting this weekend in Jeddah, Saudi Arabia to assess compliance under the December cut agreement and review market conditions.
A month ago we thought that we might see some signs out of Jeddah about what OPEC may do a month later at the full June OPEC meeting in Vienna. But now our assessment is that we will not get any clarity from Sunday’s meeting as to future OPEC decisions on adding supply or extending the cuts.
The current Game of Drones* attacks on Saudi pumping stations and tankers and now the official Saudi statement Wednesday leveling blame at Iran for the attacks likely means the start of a couple acrimonious OPEC meetings and even more geopolitical risk for oil markets.
Despite a couple of new reports that OPEC would decide to boost production at this meeting, OPEC seems to be instead staying the course and delaying any decisions until the late June meeting. In terms of messaging we are getting a repeat of the March JMMC meeting where Saudis emphasized keeping markets stable while still tip-toeing around extending the cuts which expire in June through the end of the year. The Saudis want to extend the cut agreement but the Russians are still undecided.
In our view, the three big takeaways from Sunday’s JMMC meeting will be:
1) Over-compliance on actual production cuts under the December agreement, largely due to deeper cuts by Saudi Arabia and UAE and drastic involuntary cuts from Venezuela (although Venezuela was exempt from the cut commitment). In March the JMMC said compliance in February was at 90 percent. We estimate that current production levels have OPEC back in over-compliance mode – very similar to last year’s June OPEC meeting. At that June 2018 meeting, OPEC scrambled to provide a framework to allow more production within the allowable quotas with Saudi Arabia, UAE and Russia raising production levels to address rising prices and Trump oil tweets. We could see a repeat of last year’s moves at the June 2019 meeting but the Saudis are pursuing a different strategy (see #3). We've included at the end of the note Platts' excellent chart of actual production with allowed production under the cut agreement as of March.
2) Russian resistance to extending cuts through 2H 2019 continues, as we saw in comments this week by Russia Energy Minister Alexander Novak. If it were up to Novak and Russian oil companies, they would not extend. But Putin likes the international limelight Russia receives with OPEC cooperation. However, we see a new issue emerging from Russia involving concern about surging US production (past Russia as the largest producer) and the role the OPEC cuts and higher prices play in providing incentives for more US production. We will write more about this in a future note but the Russians are increasingly concerned about market share.
3) Saudis stick to new destocking strategy to further drain global crude inventories, with special emphasis on reduced exports to the US to affect EIA weekly data. Saudi minister Khalid al-Falih has publicly expressed concern about rising crude stocks again today and the need to reduce them. Saudi exports to the US have been declining this year and we believe will decline even further before the June OPEC meeting. Remarkably, there’s been no change in Saudi actions since Iran waivers were not renewed by the US, which we believe is evidence of how committed the Saudis are to the destocking strategy. Beware of twitter rumors about Saudi production hike to offset Iran. You may see Saudi production rise as is generally the case each summer to meet domestic power needs but we do not believe there will be any increase in exports. From a messaging standpoint, the Saudis may try to get a two-for by hiking production to meet domestic needs and showing Trump they are responding with higher production.
The next month leading up to the June OPEC meeting will be dominated by Iran. The US policy of maximum pressure on Iran means maximum pressure for oil markets, and the number of geopolitical events are only rising as we head into the high-demand summer season. As a result, we see Brent prices rising above $75 as we approach the June 25 meeting.
While the jury is still out on the reported Iran attacks on Saudi tankers and pumping stations, the fact that Saudi Arabia has now officially blamed Iran is very significant in our view. If you are Saudi Arabia, or any country for that matter, and your arch-enemy or its proxies just made two attempted attacks on major critical infrastructure, don’t you have to respond?
Also, the US State Department, as well as US oil companies, are moving non-essential personnel out of Iraq due to intelligence about possible Iran or proxy attacks on US interests or citizens. If there is such an attack, the US will also have to respond. An attack also increases pressure on Europe to abandon its détente with Iran.
Of course, any US, Saudi or Israeli attack on Iran would spike geopolitical risk and oil prices.
Iran is not happy with the US decision not to renew oil waivers but are even more unhappy that the official White House statement explicitly said Saudi Arabia and UAE will pick up the slack from lost Iranian barrels and essentially take Iran’s customers. This will be a major point of contention at the upcoming OPEC meeting.
Also, we think Iran believes higher oil prices would hurt Trump politically so attacking critical infrastructure in Saudi Arabia is not so far fetched, and we could see more such actions.
* NOTE: Hat tip of thanks to our friends at Tellurian investor relations for coining Game of Drones in its excellent daily market recap. To sign up for their email reports, go to Tellurian's website.