Well (get it?), it’s become apparent over the past two months that the whole “these production cuts will balance the market” narrative has virtually no merit for crude.
Global demand is on shaky footing. That’s a given. It seems entirely possible that the pace of global growth and trade was permanently impaired by the crisis.
So there’s that.
But there’s also the common sense assessment of the shale dynamic. Central bank largesse allowed otherwise insolvent production to basically hibernate during the downturn. The very second the production cut agreement drove prices back up, that production came back online – with a vengeance. Needless to say, Wall Street (and you) has been more than willing to finance the “renaissance”.
Now it’s a stalemate. Rising US production and swelling inventories versus OPEC cuts. Compounding the problem for the bull thesis is the “read between the lines” message emanating from Riyadh. It goes something like this: “we started from a debt-to-GDP ratio of 2% and the world is hungry for our debt, so if you think we’re facing some kind of existential budget crisis, you’re wrong.”
That was implicit and last week, Deputy Crown Prince Mohammed bin Salman made it explicit.
Still, investors and traders aren’t ready to throw in the towel (the recent sharp reduction in spec longs notwithstanding). “The options market is suggesting that investors are buying the dip, with the expectation that OPEC and Russia will come through on the output-cut extension,” BNP’s Harry Tchilinguirian said on Wednesday.
Here’s a quick rundown of where things stand for individual producers ahead of the May 25 OPEC pow wow, via Bloomberg…
Key crude producers achieved targets under the OPEC-led production-cuts plan by shutting fields for maintenance. They can’t repeat this in 2H, making reductions more painful and raising prospect that compliance may dip, writes Bloomberg oil strategist Julian Lee.
- Extending cuts will mean countries and companies giving up growth they were counting on to boost full-year revenues
- Temptation for individual members to cheat will be strong, as long as they think Saudi Arabia and other Gulf Arab countries will continue to cut
- Meanwhile, Libya, Nigeria are both boosting output with return of flows that have been shut in for many months. If sustained, they will further undermine cuts elsewhere
- Saudi Arabia has cut more production than it pledged so far, but this may not continue as domestic needs increase
- Kingdom’s use of crude for power generation will rise alongside temperatures, also reducing volume available for export
- Direct crude use rose by ~450k b/d between winter and summer last year, even after start of Wasit gas project
- Saudi end-January crude inventory lowest for 5 years
- Iraq’s rising capacity in its southern fields will add pressure to boost supply. Country aims to be able to produce 5m b/d by end 2017
- Eni to add 200k boe/d treatment facility at Zubair this year; China’s CNPC to double Halfaya output to 400k b/d by end 2018
- U.A.E. oil field maintenance helped country cut more than it promised in March, April, allowing it to meet target on average over 6 months
- Kuwait shut facilities at fields in south, east of country for maintenance to curb production
- Maintenance at Mina Abdullah, Mina Al-Ahmadi refineries probably helped Kuwait to maintain exports while cutting production. Their return to full operation means Kuwait will feel full effect of output cuts in lower exports
- Qatar carried out maintenance at Al-Shaheen field, cutting available volumes in January
- Russia extending, or deepening, cuts would require companies to lower planned production by forgoing capacity expansion plans or cutting old fields
- Rosneft plans to pump 6m bbl from Yurubcheno-Tokhomskoye this year after start-up; Lukoil to ramp up new wells at Caspian Sea Filanovsky field; Gazprom Neft’s Russian output to rise by 7.8% this year, according to Sberbank
- Kazakhstan’s rising Kashagan output will more than offset cuts elsewhere
- Output from field could hit 300k b/d by end 2017
- Production averaged 190k b/d since end-September: Eni
- Libya’s output has risen above 800k b/d, highest since 2014
- Nigeria is poised to resume exports Forcados after pipeline repair
- Monthly programs show grade loading averaged 200k b/d in 2015 before flow was stopped in February 2016
In a testament to how sure the market is when it comes to the “expected” extension of the production cuts, BofAML notes that “despite oil weakness comparable to November ’16 lows, the FX market has been complacent about the upcoming OPEC meeting on May 25.” Here are some excerpts from the note..
What’s priced-in for OPEC?
Despite oil weakness comparable to November ’16 lows, the FX market has been complacent about the upcoming OPEC meeting on May 25.
We see value in CAD and NOK gamma at current levels, still below what was priced-in for the November meeting (Chart 1).
By contrast, oil options are pricing an uncertainty premium vs. realized (Chart 3).
Our commodity team remains bullish oil and there is some uncertainty over possible OPEC decision to extend cuts. The risk is OPEC disagreement and no concrete action taken at the May meeting.
Yes, that’s quite obviously “the risk.”
And should an “adverse” scenario materialize, it could well be the straw that broke that camel’s back for an EM complex that’s so far managed to shake off a Fed tightening cycle, metals mayhem, and a Chinese economy that looks like it’s rolling over.