When the OPEC meets Nov. 30, market participants expect the cartel to continue with its production cuts, first implemented a year ago. That view is based on comments various cartel officials made over the past month, such as OPEC secretary general’s announcement in October that the cartel may take “some extraordinary measures” in 2018 to reduce any inventory surplus.
Saudi Arabia’s Crown Prince Mohammed bin Salman said previously he supports extending the cuts, and critically, non-OPEC member Russia also is in favor of lowered output. Russia collaborated with OPEC on last year’s decision to reduce crude oil production. Energy experts say given that Saudi Arabia is OPEC’s largest oil producer and Russia controls one of the largest non-OPEC supplies, their public blessing is a good indication of what will happen at the official meeting.
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Rob Haworth, senior investment strategist with U.S. Bank Wealth Management in Seattle, says higher oil prices since early October for both the global Brent benchmark and the U.S. West Texas Intermediate reflect this growing confidence of reduced OPEC supply. Brent prices have risen 28 percent and WTI 15 percent from their October lows and are now at two-and-a-half-year highs. “The market certainly has priced those cuts in very well,” Haworth says. “At this point there is a lot of pressure on OPEC to follow through.”
Since OPEC instituted the production cuts a year ago, Brent and WTI prices rose 26 percent and 19 percent, respectively. OPEC’s compliance with its stated production cuts came as a surprise because the cartel is notorious for ignoring its own quotas.
OPEC originally instituted the production cuts to help offset the massive oversupply of crude oil, brought on by the rise of U.S. shale oil production, that suppressed prices the past few years. In an effort to destabilize the U.S. producers, in late 2014 OPEC changed its usual policy of price stability to one of grabbing market share by increasing supply and causing prices to plummet.
Prices have only started rising since mid-summer 2017, as the world worked through the excess supply. As a result, the supply and demand are more balanced today. “OPEC compliance has helped, slightly higher demand growth has helped, a synchronized, growing world economy has been a huge help,” Haworth says.
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Jay Hatfield, New York-based co-founder and president of InfraCap and portfolio manager of its master limited partnership exchange-traded fund (ticker: AMZA), also attributes the recent rise in prices to strong demand. The other reason Saudi Arabia wants to continue the production cuts, Hatfield says, is its pending initial public offering for a piece of the state-owned oil company, Saudi Aramco. “We think the fact that they’re still committed to an IPO means their bias is toward maintaining production quotas, and therefore extending cuts,” Hatfield says. “Whether that is going to get formalized at this meeting or a later meeting isn’t as critical.”
In a research note, Goldman Sachs analysts say if the production cuts continue, with Russia complying, global inventories could fall below the 2011-2015 average, which would mean demand would finally outstrip supply. Since the summer, there’s been no significant oil surplus, and supply data from the Department of Energy shows U.S. inventory levels at slightly under 30 days of storage, which is normal, Hatfield says. “People missed the global demand story,” he says.
Market participants may listen more closely to what OPEC says at this meeting, according to a research note by Barclays oil analysts Michael Cohen and Warren Russell. They believe the cartel will forecast its production volume for all of 2018; the only question is how much. “OPEC gains from this stability, and market analysts now take the Saudis at their word,” Cohen and Russell say. “It is a powerful signal to know a maximum value to assign to [Gulf countries’] crude output in our market balance calculations.” If OPEC doesn’t announce anything at this meeting, that could cause prices to pull back, Cohen and Russell say.
Hatfield thinks oil prices have become a bit rich at current levels. He and Goldman Sachs forecast average 2018 oil prices at $55 a barrel for WTI, with Hatfield saying the upper end of prices could hit $65. Barclays anticipates average Brent oil at $60 for the fourth quarter and at $58 for the first quarter of 2018.
After having taken a back seat the past few years, geopolitics also could affect prices. Goldman says with inventories closer to the five-year average, the potential for any disruptions should have a greater effect on pricing, particularly supporting global Brent prices relative to U.S. WTI prices.
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That was the case in early November, as oil prices ticked up following news of the arrests of several Saudi princes on corruption charges. Hatfield, however, says the arrests shouldn’t affect oil output. When Crown Prince bin Salman consolidated his power, he “increased the probability of that plan [to continue production cuts] being executed because he eliminated the competition,” Hatfield says.
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