Just 24 hours after OPEC appeared on the edge of splintering, Iran seemed to cave and in a deal that was described as a victory for everyone, OPEC member states and Russia provided a vague assurance they would boost output by striving to return to full compliance of the original production quotas as set in the 2016 Vienna production cut agreement.
As Goldman summarized in its post-mortem, "no further details were provided, including no country level allocation, no guidance for non-OPEC participants or timeline for the increase." Furthermore, during the press conference following Friday's deal, the one question which never got an explicit answer is how much output would be boosted by, with little clarity shed beyond “targeting full compliance at the group level”.
This suggests that there is room for countries with spare capacity to increase production above the individual quotas but also that such adjustments could not be resolved.
As a result, Goldman's energy analyst Damien Courvalin said that he views today’s agreement "as masking disagreements within the group and a potential start to the unraveling of the deal, with core-OPEC and Russia looking to increase production but Iran opposing such an increase."
Bloomberg's Javier Blas confirmed as much, noting that Friday’s agreement was a "fudge in the time-honored tradition of OPEC, committing to boost output without saying which countries would increase or by how much" a fudge which gave every member - especially Iran which by endorsing a production boost would have been seen as effectively approving of Trump's sanctions and allowing other states to take its market share - an "out" to save face, by sufficiently masking up the details so no explicit accusations of backtracking can be made.
Importantly, "it gives Saudi Arabia the flexibility to respond to disruptions at a time when U.S. sanctions on Iran and Venezuela threaten to throw the oil market into turmoil."
“It is very clear that Saudi Arabia, worried about prices running higher going forward, is trying to put in place a near-term cap on prices,” said Yasser Elguindi of Energy Aspects Ltd., a consultant. “Having secured its floor, Riyadh would like to see a near-term ceiling of $75.”
Which, incidentally, is also the price above which Trump tends to take to twitter in bashing OPEC. And not only Trump: oil prices have recently gotten so high, they have led to political fallout among mostly Developing Nations such as India, whose petroleum minister rang Al-Falih last month and expressed “concern about rising prices.” A week later, it was the head of China’s National Energy Administration on the phone with the Saudi oil minister, asking Riyadh to guarantee adequate supplies.
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So what is the actual production boost? This is where the confusion really sets in. First, here is Goldman's take:
Several ministers suggested that this would correspond to a 0.7 mb/d increase in production, which would represent OPEC returning to its aggregate production quota. Such an increase in production would likely only be gradual, leaving it on a path close to our base case 550 kb/d increase in 3Q18. While production could exceed our 550 kb/d expectation for 4Q18, we see risks that Iran production may be even lower than we assume. As a result, we view today’s announcement as coming not far off our base case and as a result our price forecast and outlook remain unchanged.
Bloomberg referenced a similar number, noting that the deal could add about 700,000 barrels of daily supply from OPEC and non-OPEC producers. To get there, Russia will probably raise output as much as it can while Saudi Arabia attempts to adjust its production to manage prices.
On Saturday morning, however, the discrepancy grew, with various soundbites estimating the boost based more on political tensions than actual production dynamics, and ranging from under 500kb/d to over 1 million:
A bigger issue is that as BBG notes, traders are far from confident that all those barrels will materialize. The alliance faces multiple risks: the loss of Iranian and Venezuelan exports because of U.S. sanctions, volatile environments in Libya and Nigeria, and hurricane season in the Gulf of Mexico. At the same time, there is a shrinking amount of spare production capacity globally.
“They cannot control the upside at the moment,” tweeted the market’s most vocal bull, hedge-fund manager Pierre Andurand. “Same as in early 2008.”
Goldman, which like Andurand has been extremely bullish the commodity sector recently, agreed:
Even under a more aggressive production scenario, we don’t believe that today’s announcement threatens to create a large reversal in fundamentals. For example, if OPEC were to plug its production shortfall (+0.7 mb/d) and Russia add 0.2 mb/d for the whole of 2H18, we would only expect a slim market surplus of 0.1 mb/d yet this would require an unprecedented increase in core-OPEC and Russia production and would leave the market with little remaining spare capacity.
But the best indicator of the market's response to the deal was the price of oil itself, which soared the most since OPEC's November 2016 meeting (even if still modestly below the May highs).
Commenting on the price action, Goldman said that "oil prices were able to maintain their price gains despite an ambiguous press conference," confirming the bank's take that the market had likely priced in already a 0.8-0.9 mb/d OPEC increase."
So in conclusion, what will happens next? Here we offer two takes, a long-term one from Goldman, which is confident that the OPEC deal was much ado about nothing:
Even if today’s agreement marked the beginning of the end of the production cooperation, we believe that core OPEC and Russia would likely have settled on a similar outcome, if not smaller, to achieve both higher output, stable inventories and not a sharp fall in prices. In the case of Saudi, supporting prices helps fund its economic diversification and maximize the value of the assets it is selling while higher production prevents high prices that would hurt consuming nations that either provide it with security or will be important in its economic transition (US, China, India). President Trump's tweet after today's announcement further reinforces this view. In the case of Russia, collaboration with Saudi increases its sphere of influence although the country no longer benefits from rising prices: the state saves excess oil revenues in foreign assets leaving for little impact on current activity while rising domestic fuel prices are keeping the CBR more hawkish.
Incidentally, on Saturday morning the big news was that OPEC had invited Russia to join OPEC as an observer, a move that could portend a dramatic shift in the balance of power as OPEC+Russia now openly take on the marginal price setter, shale. That said, for now Russia is not in a hurry, with its energy minister Novak saying he has no plans to join OPEC as a full member, yet.
As for the market's short-term reaction, one which matters far more for traders, we present the take from Swiss energy consultant Olivier Jakob who had what may be the most accurate take:
crude oil markets closed Friday on the Iranian oil minister interpretation of the deal, will open Sunday on the Saudi energy minister materialization of the deal.— petromatrix (@petromatrix) June 23, 2018