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The Only Reason Why OPEC’s Oil Deal Might Last

by | published December 1st, 2016

Yesterday, at its regular meeting in Vienna, OPEC confounded many of the pundits and hammered out a historic production cut aimed at boosting oil prices.

In response to the announcement, oil prices went on a tear. WTI (U.S. oil futures) shot up 9.3%, while Brent (global oil futures, set in London) were up 8.7%.

Crude oil, midstream, and oil field service companies experienced double-digit gains almost across the board, with the sector experiencing its strongest percentage daily advance in almost three years. In contrast, the broader S&P ended up declining for the day.

While there is going to be some pullback, WTI is now approaching $50 a barrel, while Brent is already above that level.

But if you thought the months of negotiations were hard, wait until you see what’s next…

Because now that the Vienna Accord has been agreed on, OPEC will have to make sure it actually takes effect in January.

And then make it last long enough to rebalance the market, and permanently boost oil prices.

Here’s the only reason to think that might work…

Our Oil Price Forecast is Coming True

For the record, we are moving ahead to hit the pricing estimates I have been predicting ever since the meeting in Algiers at the end of September: $52-$54 a barrel in New York by the end of this year; low $60s by the end of the first quarter of 2017. Brent prices in London should be $2-$3 above New York.

Of course, all of this depends on countries sticking to the oil deal come January, when it’s meant to kick in.

The details of the deal fit with what I’ve been discussing for the past week, following my Persian Gulf meetings with some of the main global energy players through last Thursday.

OPEC has collectively agreed to reduce production to an aggregate 32.5 million barrels a day. That matches the cartel’s October levels and amounts to a reduction of about 1.2 million barrels, or about 4.5% of current volume.

The cartel finally agreed to exclude Nigeria and Libya from the cut. Both have been experiencing significant domestic instability that has been wreaking havoc with their oil production. Iran, in turn, agreed to cap its production at current levels…

Iran Finally Got On Board

Now, you’ve already seen, here in Oil & Energy Investor, why concerns about Iran not agreeing to a cap are overdone. Sure, Tehran still wants to reach the oil production levels it had prior to the recently lifted Western sanctions. At 4.2 million barrels a day, Iran is already a few hundred thousand from reaching that objective.

But the country faces significant domestic field and infrastructure problems that prevent Iran from increasing and sustaining production beyond current levels.

As a result, Theran has agreed to cap production at its present level – where, effectively, its own internal problems force the country to remain anyway.

Iraq is still a wild card, but Baghdad has, at least for now, signed on.

OPEC must still divvy up the agreed cuts between member countries. That’s still a contentious issue since Saudi Arabia is apparently cutting less than initially thought and will have to exercise its usual function of OPEC enforcer.

In the past, the Saudis did that by increasing or decreasing their own production to punish other cartel members. But following two years of OPEC defending market share instead of oil prices by keeping the taps open, that’s unlikely to work.

As you saw in Tuesday’s letter, you should expect some cartel members desperate for revenue to produce more than their quotas allow. That may increase the actual volume moving into the market from OPEC members to a level close to 33.2 million barrels a day – some 700,000 barrels a day more than the deal’s official limit.

The key is to bring the global market into a balance between supply and demand. And that highlights what can well be the least controllable aspect of OPEC’s Vienna accord…

The Deal Won’t Work Without Russia

For the deal to have any chance of working, OPEC needs to obtain at least 600,000 barrels a day in cuts from non-OPEC producers. At least half of that (300,000) must come from Russia.

My sources indicate that proposal met a stony response when it was first proposed in Moscow on Sunday. And following yesterday’s announcement of a deal in Vienna, the Kremlin’s response was a cautious (but rather cryptic) acceptance.

Behind the scenes, a number of my global contacts were telling me this morning that Russia will once again agree to a cut – and then not follow it. That’s been the pattern in several OPEC-Russia deals in the past.

And that’s a problem, because the OPEC deal means little if it cannot be sustained for long enough to allow the market to rebalance.

Once again, I expect Asia will become a renewed battlefield between Saudi Aramco and Russian Rosneft – two of the most powerful national state oil companies in the world. There, the fight for market share will continue.

But with both countries seeking to privatize a portion of these companies, they also have other goals in mind – goals that give some hope the Vienna deal may stick…

Both Russia and Saudi Arabia Need Higher Oil Prices

The funds resulting from a minority share sale of Aramco will be the initial stage in Saudi Arabia’s post-oil investment and economic diversification plan. Meanwhile, Rosneft already has 25% of its shares in private hands and trades on both the London and Moscow exchanges, but selling more is in the works to plug Russia’s budget deficit.

That means Rosneft’s management has to contend with returning share value to investors, not just projecting central government policy. The Saudis will face a similar challenge once Aramco shares are sold.

In both cases, the value of the stock offers will be set by the value of the underlying assets. And that, essentially, is predicated on the price of oil.

So what both Saudi Arabia and Russia need is still higher oil prices. That may just be enough to keep the Vienna Accord together in 2017.

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  1. Joe shangraw
    December 1st, 2016 at 16:58 | #1

    When it was 130.00 a barrel we paid 1.20/ Lt. Now its 50.00 a barrel and we pay 1.00/Lt. Close to a third the price per barrel and we pay 80% of the the old price. No one seems to sees that we are taken advantage of no matter the price per barrel. Hope they drown in it.

  2. richard donnellan
    December 1st, 2016 at 18:15 | #2

    for the last two years saudi and russia have been pumping full on. Yes orNo? therefore at least some fields must be running down and machinery wearing out thus reducing exporting production anyway. So China’s growth is slowing but . . it is sill actually growing and India’s is leaping forward USA is dropping production rapidly and even iffracking etc. restarts it takes time. Replacing nuclear via eg Hinckley UK will take 20 years . Go for Gas and USA exports to Uk and Europe so undercutting Russia. Obvious innit!?

  3. JTempleton
    December 1st, 2016 at 20:57 | #3

    Prices will be substantially higher than your conservative predictions by the end of Q1-17. By end of Q2 a global shortage will begin and prices will skyrocket. 10 year shortage at best…my prediction…California gas pumps will be $6+ a gal by Q4-17

  4. Edward orlando
    December 2nd, 2016 at 07:09 | #4

    This whole OPEC attempt to cap & control oil prices will never attain it’s goal. Russia will always produce it’s maximum and by Fall of 2017 prices will top $65/barrel. We will at some point in mid year increase our oil production and stabilize our oil import needs forcing IPEC to renegotiate it’s goals.

  5. December 3rd, 2016 at 12:26 | #5

    The line between production and demand is too close, we knew in 2014 that to be the fact! It’s like driving from Texas to NY with no gas stations and no map, does not matter what’s in the reserve tank if you can’t control the trip (demand) when you run out of the reserve tank (glut) we will HAVE to pay what ever the price. As I left the Permian in 2015, I wrote down and told many people that by the election in 16 oil would be rising, the truth about the glut would come out and it did, in 2014 we had 1100 + rigs running in the US and today 350, it’s “Houston we have a problem” not enough production, limited oil in the tank and higher demand, oil is about to surge!

  6. Bob Schubring
    December 3rd, 2016 at 21:01 | #6

    The simplest move Russia could make, is to pick a reduced level of production out, and call it the Russian Standard Output. Any oil sold, in quantities exceeding Russian Standard Output, would be surcharged a pumping fee of 10-15%, for delivery to Pacific ports or the Chinese border.

    What makes that a smart deal, is that oilfield and pipeline equipment requires downtime for maintenance. If Russia were to idle 10% of their wells and pumping capacity, on a rotating basis, while maintenance is done, the huge pumps that shove oil at high pressure, through the pipeline to Asia, would use energy more efficiently. In an emergency (such as another shooting war between Middle East countries that cuts off supplies of Persian Gulf oil to China), those Russian fields and pumps could run faster, and Russia would have to divert energy from other uses to keep them running, but China would continue to receive oil, while the Middle East sorted itself out.

    The past two years of go-for-broke oil pumping, has proven the concept to be workable.

    It’s up to Russia to convince China to pay them money, to keep oil on reserve for an emergency. Beyond a doubt, war is a risk in the Mideast. It affects China’s oil supply. Instead of depending on US troops to stabilize the Mideast, it makes more sense for China to pay Russia to keep a reserve of oil delivery capacity, on reserve, in case of Mideast instability.

    It would be a very smart counter-move by China, to the Trump Administration on trade, as well. Trumpians argue that the US should be paid for the troops we send to defend other countries. A hold-reserve-production deal for Russian oil, may be smarter for China, than depending on the US to police the Mideast or trying to do that themselves.

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    December 4th, 2016 at 04:02 | #7

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