Oil fell from two-year highs on Monday amid what’s being widely described as skepticism about Russia’s commitment to committing. And no, there are no typos there.
Apparently, there’s a general agreement from OPEC and non-OPEC allies that an extension is inevitable, but the details are still up in the air with Russia proving to be the stickler.
“The relationship between Saudi Arabia and Russia risks being weakened by the very goal that first brought them together,” FT wrote on Sunday, adding that “Russia has voiced concern that oil’s rally, while broadly benefiting its economy, could unleash rival supplies on to the market [and] Russian producers are hamstrung by the deal and have lobbied Putin against agreeing an extension.”
Keep in mind that Moscow and Riyadh are on opposite sides of the fight in Syria, with Russia backing Assad and by extension Hezbollah against all comers. On one hand, cooperation on crude could foster an amicable relationship between the Saudis and Putin at a time when things are on knife’s edge between Nasrallah and the Kingdom. On the other hand, it’s certainly not a situation where everyone can just pretend as though the alliance between Moscow and Tehran doesn’t run counter to the Saudis’ efforts to counter Iranian influence.
“Russian dithering on the timing of a decision of an extension or its duration is exactly what can make the oil market nervous,” UBS said Friday, before warning that “should the outcome of the meeting fall short of expectations, the large net long speculative position on oil futures can unwind, sending prices lower and volatility higher.”
All of this against a backdrop where no one is quite sure what to expect from US production. “Analysts briefing OPEC last week said forecasts of growth in shale oil output next year ranged from 500,000 barrels a day to 1.7 million,” Bloomberg’s Julian Lee wrote over the weekend, on the way to reminding you just what that means: “that margin of uncertainty is as big as the entire output cut the group agreed to a year ago.”
Well on Monday evening, Goldman is weighing in and their take reflects the ambiguity inherent in everything said above. To wit:
Russia appears less convinced on the need for such a long extension and the accompanying higher oil prices that Middle East OPEC producers likely welcome.
Comments by Russia over the past year that the cuts should remain data dependent to assess their effectiveness further suggests it will likely seek to avoid committing to a nine month extension until closer to the cuts’ expiration. More broadly, we see a increasing disconnect between the rhetoric of a nine month extension, four months before the cuts end and in the face an accelerating rebalancing and the logic of a short-duration cut to normalize inventories followed by higher output to increase revenues and market share. Given this set-up, we believe that the outcome of this week’s meeting remains more uncertain than in past years.
The upshot: risks are skewed to the downside with crude having largely priced in a nine-month extension. As the bank goes on to write, “the record net long speculative length across the oil complex suggests downside price risks into this OPEC meeting, as was the case in June 2015 and May 2016.” Here’s the chart on that:
Goldman does note that while the risk may be skewed towards a knee-jerk reaction lower, they’re not calling for some kind of catastrophe:
To be clear, we do not expect a month-long collapse in oil prices like the one that occurred after the May 2017 meeting either, as the lack of a nine month extension would be in response to strong fundamentals. Despite the lack of an agreement so far, there are no indications that the meeting could end without some form of extension, with, in our view, a strong incentive to formalize collaboration for 2018 and beyond with the group returning to broadly following quotas like it did in the 1990s, when it doubled production.
Given that, you’d have to think that Goldman’s 2018 Brent forecast is probably a bit on the conservative side and if that’s what you were thinking, you’d be correct (although the bank is apparently sticking with their longer-term outlook):
The announcement of a nine or even six month extension would be at face value bullish relative to our forecast of a gradual ramp up in OPEC & Russia production next year from April onward. Specifically, we expect production to increase by 600 kb/d in 2Q-4Q18 vs. 1Q18, on the view that OPEC will aim to maintain inventories normalized (on a days of demand coverage basis) and given our non-OPEC ex. Russia supply and global demand forecasts. While a six or nine month extension would therefore leave risks to our $58/bbl 2018 Brent price forecast skewed to the upside initially, our fundamental projections and conceptual oil framework would still lead us to expect that compliance would deteriorate and that OPEC and Russia would grow production and prices subsequently decline.
The bottom line is the same as it always was. Namely: if geopolitical risk doesn’t flare up further and lead to disruptions, prices at current levels are above the industry’s marginal cost of production, and that means it won’t be long before more non-OPEC supply comes online, a state of affairs which would invariably lead the cartel to rethink their aggressive jawboning and ramp back up in order to avoid lost market share.
And up the down escalator we go.
