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Takeaway: Elusive Trade Deal Complicates Task But Base Case is Cut Extension of 3-9 months

Editor's NoteBelow is a complimentary research note by Hedgeye Energy Policy analyst Joe McMonigle. If you would like access to his institutional research email sales@hedgeye.com.

OPEC In Prevent Defense, But Don’t Dismiss Surprise Deep Route - 11 27 2019 8 15 51 AM

Next week Vienna will see heavier than normal traffic as the city hosts not only OPEC+ ministers arriving for its winter meeting but also the IAEA special general conference to select its next Director-General.

This means that Iran’s Foreign Minister Javad Zarif will be in Vienna with US oil sanctions and the Iran nuclear deal mixed into oil headlines.

For OPEC, the situation is more fluid than normal before a meeting over the last couple years.  As a result, actual decisions will likely be made at the meeting and not prior to the meeting via WhatsApp messaging. Already OPEC is buying more time to reach some consensus by moving the JTC meeting up to Dec 3 from Dec 4.

The reason for the fluid situation is the lack of a trade deal that was supposed to be announced or finalized by the Dec 5 OPEC meeting. The trade pact now seems to be slipping into next year.

As a result, OPEC once again has to address two factors: physical supply/demand and also a bearish trade narrative’s impact on the global economy. If OPEC only had to address one factor, it would be an easier meeting.

In our view, the base case going into the meeting is a 3-month extension that takes the cuts to the June meeting with extra emphasis on greater compliance by laggards Iraq and Nigeria. Many in OPEC will view this as the safe scenario (waiting out a trade deal) but we believe the market will view this insufficient and prices may weaken. So while we put the odds of a 3-month extension currently at 70 percent, it’s in a precarious position and losing steam as the realization of weaker prices becomes more apparent.

Saudi Arabia and some other producers are looking for a bullish outcome or at a minimum preventing a decision that sends prices falling. Therefore, in our view, we see some potential for a surprise decision of deeper cuts – a scenario that may revert to the previous OPEC+ deal of 1.8 million barrels per day (b/d) vs. the current 1.2 million b/d cuts. It's a long shot but we give it better odds at 40 percent.

Absent deeper cuts, we believe Saudi Arabia and others will push for a longer extension until the end of 2020 and will insert the standard "review of the deal and market conditions" language (favored by Russia) at the June meeting.  Currently we give it 50/50 odds but rising every day as the favored course of action.

Lastly, there are some pushing the notion that OPEC does nothing and punts a decision on extending cuts to a special meeting in March when the current agreement expires.  We think this is highly unlikely due alone to the almost certain price slide that would result.

The Iranian Foreign Minister’s presence in Vienna for the IAEA meeting while OPEC meets is likely to create more headlines about US oil sanctions and the Iran nuclear deal.  There is an emerging bearish oil market narrative that sees Iranian oil coming back into the market in 2020 on the belief that President Trump will be desperate to sign some deal next year or Secretary Pompeo’s potential departure to run for Senate will leave the administration without any Iran hawks.

We don’t give this concept much credibility. Trump would welcome a deal but it will require concessions from Iran that it has not been willing to do.  In our view, it’s a huge mistake to assume Trump wants a deal for deal’s sake on Iran. If anything, we see the window for such negotiation closing when Trump enters his reelection year. Whatever you think of President Trump, his administration has been remarkably consistent on Iran policy.  As a result, we believe it is an unlikely scenario for significant Iranian oil exports returning to global markets in 2020.

ABout joe mcmonigle

Joseph McMonigle serves as Senior Energy Policy Analyst at Hedgeye Potomac Research and is president and co-founder of The Abraham Group LLC, an international strategic consulting firm focused on the energy sector and based in Washington, D.C.

Mr. McMonigle is the former Vice Chairman of the Paris-based International Energy Agency, an international organization of oil consuming countries, whose core mission is to work for stable energy markets and respond with joint measures to meet oil supply emergencies. He also served concurrently as U.S. Representative to the IEA (2003-2005). In addition, Mr. McMonigle served as Chief of Staff at the U.S. Department of Energy, a cabinet department with a $23 billion budget and over 100,000 federal and contractor employees (2001-2005). Mr. McMonigle also served as the American co-chair of the U.S.-China Energy Cooperation Working Group and led DOE’s bilateral activities and engagement with China.

Before joining the Bush Administration, Mr. McMonigle was the administrative assistant and general counsel to a United States Senator. He is also an attorney and member of the Energy Bar Association as well as the Pennsylvania and District of Columbia bars.