Alongside the US election, the other big event for markets next month will be OPEC’s meeting, held on November 30.
After agreeing tentatively to a production cut in next year in late September — reducing production by 750,000 barrels per day to 32.5 million barrels — the question everyone is now asking is will the deal actually stick?
Since the announcement from OPEC on September 28, the overwhelming theme expressed by markets is scepticism over whether the deal will be inked.
Several OPEC members, most recently Iraq, have expressed concern over the mechanics of the deal, with squabbling over production quotas fueling doubts, and weighing on prices, ever since.
While many believe that the most likely outcome is for the deal to fall over, with vested self interest trumping the need for unified, price-boosting action, there are plenty in markets who believe it will still get over the line.
Helima Croft, Michael Tran and Christopher Louney of RBC Capital Markets certainly believe it will, suggesting that there are several factors at play that makes it imperative that a united front prevails.
“While a corner of the market remains skeptical that OPEC will be able to stick the landing and follow through with the production cuts announced in Algiers, we remain of the opposite view,” they said in a research note released on Thursday.
“It is imperative that OPEC and Saudi Arabia, in particular, live up to the guidance it recently signaled for several reasons. Not only will the lack of follow through solidify the view among market participants that OPEC is defunct, but a significant amount of fresh longs and short covering has occurred over recent weeks.
“Failure to launch will undoubtedly send the market reeling back into the low $40/bbl price environment, or lower,” they say.
On Iraq’s request to be exempt from production quotas under the proposed deal, RBC believe that the issue will be resolved before the OPEC meeting, suggesting that it “does not have the financial bandwidth to play hardball and cannot afford a fall in prices if the OPEC deal were to fall through”.
Adding to the urgency for an OPEC deal, Croft, Tran and Louney suggest that many US oil producers have taken advantage of the recent price spike — brought on by the announcement of the tentative OPEC deal — hedging out exposures to future fluctuations in the market.
“A significant amount of US producer hedging has taken place as term prices have trended into the low to mid $50/bbl range,” they say.
“Shoring up hedge ratios simply means that US production becomes increasingly price agnostic and will grow from current levels, thus potentially overwhelming an already fragile market.”
Insensitive to any potential downside movement in the crude price, in other words, allowing production levels to remain firm regardless of market movements.
Not exactly an ideal situation given the crude markets remain oversupplied.
Writing earlier this month, Vivek Dhar, a mining and energy analyst at the Commonwealth Bank who believes there’s more chance the OPEC deal will fail than succeed, outlined the threat posed by US producers, even if an OPEC deal is struck.
“Even if OPEC manage to agree to a deal and boost prices above US$50 per barrel, there is every chance that US will deploy rigs and boost production at those price levels,” he said.
“US oil rigs have increased 34% since late May despite oil prices remaining in the US$40’s.
“Even if it did [a firm agreement by OPEC member be inked], the ultimate unintended consequence for OPEC may become a reality – they concede market share to US and prices remain subdued.”
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