‘At It Again’: OPEC Deal Postmortem

We know prices in the three digits were causing instability. I can tell you that as we approach that range of prices, we feel that instability would be back.

That’s from Saudi Oil Minister Khalid Al-Falih speaking on Friday and it marks an amusing contrast with reports out earlier this year that suggested Riyadh was angling to push oil prices as high as $100/bbl.

The about-face (which manifested itself first in a series of comments on May 25 indicating that Saudi Arabia and Russia would move to boost supply in the back half of the year) came courtesy of Donald Trump and back channeling from U.S. officials who put pressure on the Saudis to cap the inexorable rise in crude prices so as to avoid a scenario where higher prices at the pump endangered the GOP tax cuts.

Visually, Trump is concerned about this:

And anecdotally, he’s worried about this (from BofAML’s latest “Word From Main Street” survey):

For good measure, Trump reiterated his consternation in another “at it again” tweet a week before the meeting in Vienna:

Oil prices are too high, OPEC is at it again. Not good!

— Donald J. Trump (@realDonaldTrump) June 13, 2018

The rumor mill was in full swing headed into Friday and generally speaking, most reports were tipping a supply increase that was markedly lower than the highest estimates and, apparently, lower than what Russia was pushing for. Those reports were at least partially borne out when the cartel decided on a nominal output increase of 1 million bbl/d which, in real terms, works out to roughly 700k bbl/d.

On Saturday, the Saudis indicated that the “real” figure would actually be close to the 1 million bbl/d and Russia’s Novak agreed: “I think the real increase of production would be a figure exactly close to 1 million” he told Bloomberg TV.

Whatever the outcome, the deal was the culmination of tense negotiations with a recalcitrant Iran, represented by an at times visibly irritated Bijan Namdar Zanganeh, who generally stuck to the defiant rhetoric from OPEC representative Hossein Kazempour Ardebili, who last weekend said this:

We as Iran, and I hear Iraq and Venezuela, are against any increase in OPEC production. I am confident many other OPEC members feel and act the same. Our OPEC and DOC agreement has a date until end of the current year. We call upon our brothers in OPEC and Russia that we do not need to appease Trump, who sanctions two OPEC founders and also Russia.

According to Bloomberg, Prince Abdulaziz bin Salman (Saudi Arabia’s state minister for energy affairs) and Al-Falih managed to talk Zanganeh off the ledge on Friday morning.

“It wasn’t easy, but everyone found a way to navigate the obstacles,” one minister told Bloomberg, adding that “the Iranian resistance was strong and the communique is the art of finding the middle ground.”

Well, that “middle ground” ended up catalyzing the best day for WTI since the November 2016 deal:

Despite that, some folks are apparently betting on a quick slide. “Volume on August Brent $73 puts jumped above 12,000, while volume on August WTI $60 puts popped above 10,000,” Bloomberg wrote on Friday afternoon, adding that “Brent August options expire early next week, while WTI August options expire around mid-July.”

Ok, so what are analysts saying? That depends on who you ask.

“Despite [Friday’s] bullish market reaction, should OPEC and Russia follow through on their commitment to raise output in line with their commitments, it would add up to 400 kb/d more to our S/D balance, bringing the market from a -0.2 mb/d deficit in H2 18 to a 0.2 mb/d surplus,” Barclays writes, adding that “given Saudi Arabia’s multiple statements in Vienna to respect the sensitivity of consuming countries and the global economy, we think that it will follow through on those commitments and raise output, capping any dramatic price upside.”

For their part, BofAML is generally sticking to its forecasts. Interestingly, they note that the reprieve from higher prices might ultimately give Trump room to squeeze the Iranians some more:

Our Brent crude oil price forecast for 2018 remains at $70/bbl, $4 lower that the forward. As for 2019, we retain our $90/bbl Q2 target as we see a tight balance throughout next year too. Plus we see the Trump administration taking advantage of any dip in oil prices to put additional pressure on Tehran, likely reducing downside risks to oil prices in the absence of a full blown trade war. Near-term, the agreement will also likely flatten Brent term structure of crude oil a bit and, in doing so, could also force a slightly narrower Brent-WTI spread in 3Q18.

That bit on Iran speaks to the self-defeating nature of Trump’s policies. As I mused last weekend, “the debate about whether to raise production to appease Trump is now the central topic of this week’s OPEC meeting and Iran is calling for a veto, which is itself ironic because it was Trump’s decision to withdraw from the Iran nuclear deal that helped embed the latest bit of geopolitical premium into oil prices.”

Here’s a bit more from BofAML on Iran:

In any case, US sanctions on Iran remain the most complex issue affecting the joint OPEC and non-OPEC producer agreement. On the one hand, reported Iran crude exports (Chart 20) have yet to decline in any meaningful way. Both in April and May Iranian exports averaged 2.4mn b/d as the National Oil Company squeezed barrels out of the country, presumably concerned about the turn in US politics (Chart 21). But there is a number of floating vessels off the Iran Persian gulf that are starting to show up, as insurance and freight challenges are already starting to disrupt flows ahead of the November deadline.

As for Goldman, Friday’s price action was something of a validation for their contention that Al-Falih’s remarks in May and the production increases those remarks presaged wouldn’t necessarily be bearish in a strong demand environment. Here’s the bank’s quick take on the deal (excerpted from a longer piece):

Net we don’t view today’s announcement as changing the market outlook, and today’s price action confirms this, in our view. Oil prices were able to maintain their price gains despite an ambiguous press conference, confirming our prior analysis that the market had likely priced in already a 0.8-0.9 mb/d OPEC increase (based on the fall in Brent deferred timespreads since May 24). Finally, 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.

That bit about Riyadh needing buoyant prices to fund Vision 2030 and to help inflate the value of Aramco prior to the IPO is obviously key. I always like to quote myself on that (as Trump would say: “I’m speaking with myself, because I’ve got a very good brain and I’ve said a lot of things“).

Here are some cobbled together excerpts from some previous pieces:

Riyadh is walking a tight rope here. Although they pledged to replace any Iranian barrels lost to sanctions, reports out prior to Trump’s April OPEC tweet indicate the Saudis ultimately want $80/bbl at least and possibly even $100. This is well-worn territory, but it’s always worth briefly rehashing. Higher prices help drive up the valuation of the Aramco IPO and while pushing prices up risks emboldening previously uneconomic U.S. supply which in turn imperils market share, that might be a gamble to Kingdom is willing to take. There’s only so much money you can extort from your relatives on the way to replenishing SAMA reserves.

Of course the Saudis are also cognizant of the effect higher prices have in terms of bolstering Tehran, whose regional influence has expanded significantly over the past several years thanks in no small part to Hezbollah’s success in propping up the Assad regime in Syria and the Houthi war of attrition in Yemen. And don’t forget the fact that the Quds basically control Iraq.

While the Saudis support Trump’s decision on Iran, they’re also pretty keen on seeing higher prices and not just in the interest of driving up the valuation on Aramco. Their are concerns about the Kingdom’s fiscal position, the necessity of financing Vision 2030 and funding the ongoing (and seemingly intractable) conflict with the Houthis in Yemen (bombs ain’t cheap, yo!)

So take from all of that what you will, and do note (as we did on Friday) that any relief at the pump you might (or might not, based on yesterday’s price action) get from an increase in production will likely be offset by the higher prices you’re going to have to pay for cars thanks to the downstream impact of the steel and aluminum tariffs and Trump’s “national security”-based auto levies.

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