OPEC Preview: oil in a bear market

OPEC Preview

December 5th, 2018

Production cut expected

OPEC and its allies convene in Vienna this week with expectations firmly favouring a supply cut in order to rebalance the market after the ramp in production seen ahead of the Iran sanctions. A cut in excess of 1m bpd seems assured, although it could be significantly higher than that. Anything up to 1.4m bpd seems anticipated, and therefore it may take more to significantly rally the market. A commitment to a longer and deeper cut will be required. Wire reports on Tuesday suggested a cut of at least 1.3m bpd is being worked on.

The meeting of the 26 OPEC and non-OPEC nations comes at a key moment for the market, with crude prices having slumped by around 20% or so over the course of October and November. The pace of that decline was startling and has undoubtedly forced a rethink of the increase in production we saw over the summer, particularly on the part of Saudi Arabia.

It’s not been alone: Saudi Arabia, Russia and the US have all been opening the taps this year. OPEC production in October hit the highest since December 2016 and was broadly flat in November. OPEC pumped 33.31m barrels in October, up 390k barrels from the month before. Saudi Arabian output is booming, climbing to a record 11m bpd. Undoubtedly this ramp cannot continue if the market is to rebalance given the declining expectations for demand growth.

Russian oil output hit a post-Soviet record high of 11.41 million bpd in October. However, this had dipped to 11.37 bpd in November. US production has surged to a record 11.475m bpd in September and is seen reaching 12.1m bpd next year (EIA). US production is now up 21% in the last year and the latest rise could mean more upward revisions to forecasts.

Trump factor

Donald Trump has repeatedly berated OPEC and others for trying to force up prices. Whilst there is pressure on the US-backed Saudi regime to acquiesce to demands to do nothing that would help lift prices, OPEC and its allies are set to push ahead. Although there are competing factions and priorities, no member wants a repeat of the collapse in prices four years ago.

US shale casts a long shadow. In particular, we must look at OPEC needing to act now to prevent a further squeeze on prices as more pipeline capacity comes on stream next year that would mean more US crude on the world’s markets. OPEC members are well aware that supporting prices is good for US shale producers, but they seem unwilling to go head to head again.

Qatar leaves

The question it leaves us with is to what extent OPEC is losing its relevance. Qatar may be a small player (approximately 2% of OPEC production), but it could suggest smaller suppliers are starting to lose faith in the Saudi-led cartel. Could it be the first domino? We must look at it in context of the regional powerplays. Whilst it may indicate a lack of consensus among members about cuts, it would be more likely to reflect the political tension between Qatar and its neighbours, in particular Saudi Arabia, which along with Egypt, the UAE and Bahrain is maintaining a trade embargo on the country. It would seem sensible for Qatar to distance its energy policy as much as possible from Saudi influence, particularly given its focus on natural gas over oil. It seems unlikely that Qatar’s decision will cast much of a shadow over the meeting or prevent an agreement.

Technical picture

Speculative positioning has turned south. CFTC figures show net longs down to their lowest in a year, down to 348k contracts by the beginning of November from 739k in February.

On the Brent daily chart, we see a firm bounce at the start of the week, with Brent breaking the downtrend resistance level and looking to push up to the 23.6% retracement of the recent down move at around $64.65. However yesterday’s failure to maintain any bullish momentum suggests there is little appetite at present for a pre-OPEC rally.