RIYADH, SAUDI ARABIA (February 19) – OPEC is preparing to make deeper additional cuts in the range of 500,000 to 600,000 barrels per day (b/d) in the second quarter in response to lower demand forecasts, according to our assessment based on discussions held here in Saudi Arabia and with other OPEC officials this week.
The cuts will be announced at an OPEC+ meeting in Vienna on March 5-6 when OPEC expects Russia will support the move. Despite the mixed signals coming from various top officials in Russia, we believe the deal was sealed in a call between King Salman and President Putin on February 3.
Russia’s slow walking of a response promised days ago and blocking of an earlier OPEC meeting is seen here as necessary for domestic political consumption, most especially with Russian energy companies.
The cuts are a direct response to the demand impacts of the coronavirus on oil markets.
We see Russia’s strategy to prevent an early February OPEC meeting and insist on the March meeting dates was in the hope that the delay may result in clearer market data that would mitigate the need for even more deeper cuts.
Saudi Arabia and OPEC does not see any material change in the data that would negate the necessity for deeper cuts, despite recent trends showing a slower growth rate in confirmed and suspected cases of the coronavirus. While slower growth rates are good news, OPEC believes the damage has been done to demand data and must be addressed.
Saudi Energy Minister Prince Abdulaziz commented on the current state of energy markets this morning in Riyadh at an symposium on energy outlooks at the International Energy Forum: “I believe that when there is a fire in your house, you call the fire trucks instead of using a garden hose.”
All of this is playing out as we forecasted in our early February client note that said there will not be an early OPEC meeting but we expect “significant deeper cuts with potential additional shock-and-awe voluntary cuts from Saudi Arabia that will at a minimum put a floor on prices but likely stabilize prices higher in the second quarter.”
In December the OPEC+ group agreed to 500,000 b/d in deeper cuts from 1.2 million b/d to 1.7 million b/d. Moreover Saudi Arabia announced a surprise voluntary cut of an additional 400,000 b/d so the total OPEC+ deeper cuts for the first quarter are 2.1 million b/d.
If, as we expect, OPEC announces additional cuts of at least 500,000 b/d, the total cuts for the second quarter will be at 2.6 million b/d. We also believe there is the potential for an additional voluntary cut from Saudi Arabia in the neighborhood of 500,000 b/d – enough to get the total deeper cuts to 1 million b/d. At this time, it’s not yet clear on the additional Saudi cuts. However, if implemented, we think it will likely be more temporary on a month-to-month basis as conditions warrant instead of in parallel with the official OPEC cuts for the full second quarter.
Two other oil market geopolitical risks that we expect to impact oil markets over the next couple months are Libya and Iran.
Libya production is offline by about 1 million barrels a day and is becoming a much serious longer-term concern. Initially, it was thought this reduction would be temporary and come back online from the end of this month. However, it now seems more likely the Libyan situation will continue to worsen and production will be shut in for the next few months at least. In his remarks this morning, Saudi Energy Minister Prince Abdulaziz expressed concern about Libya saying that he “will not be surprised if the topic at the March 5 and 6 OPEC meeting is Libya instead of the virus.”
On Iran, the conventional wisdom is that US-Iran tensions have cooled off but we do not share this view.
First, we strongly disagree with the trending narratives that Trump will want to cut a deal with the Iranians ahead of the election or the Iranians will just wait out Trump for a new President in the US election. Unless the Iranians come to the table without insisting that Trump waives oil sanctions in advance, there will be no negotiations. The Iranian economy is already deteriorating sharply from US sanctions with a restless population that means waiting for the US election does not seem like a plausible strategy. The Iranians are sophisticated enough to know that Trump is at least an even bet to win reelection based on the electoral college map.
Second, we noted with great interest comments made by the Foreign Minister of Oman at the Munich Conference late last week. Foreign Minister Yousuf bin Alawi bin Abdullah expressed concern about the potential for a “mistake” in the Strait of Hormuz due to the presence of so many military ships. The Foreign Minister has traveled recently to Tehran where he has good relations, and in our view, his comments could reflect some feedback he received from Iranian officials during his trip.
If Iran can’t wait out Trump for a new US President to be elected, it will be forced back to the “maximum chaos” playbook to try to create pressure on Trump to do a deal on Tehran’s terms for the start of negotiations (ie lift waivers). Regular readers of our Iran notes will know that we think additional Iran trouble-making via direct or through proxies is the more likely scenario. But even if not, a minimal reading of the Oman foreign minister’s comments, would be similar to those expressed by our Hedgeye colleague General Dan Christman who has written about the concern of another “mistake” like the shoot down of the Ukrainian airliner that could plunge the region into a major geopolitical crisis.
