The Fuse

OPEC Supply Risks Skewed to the Upside

by Matt Piotrowski | August 23, 2016

Oil prices have cooled off after going on a tear starting at the beginning of August amid a much-needed technical correction and a rethink from traders on supply-demand fundamentals, but markets are still hovering near $50. OPEC’s talk about an agreement on a production freeze in late September has dominated headlines, scaring financial investors with short positions—those betting on lower prices—out of the market and shoring up prices. But perhaps more important than the rhetoric about OPEC members capping production is the possibility of more supply from the cartel returning to the market. During the second quarter, a slew of production outages helped underpin prices and kick the market above $50. Recently, outages in Iraq, Nigeria, and Libya have all garnered a lot of attention since they are partly responsible for pushing fundamentals more toward balance and increased the total outages in the cartel to 3 million barrels per day. However, if supply rebounds steadily in these key producers, where there have been positive developments recently, the global oil market surplus could balloon again.

“Thawing relationships between parties in conflict in areas of disrupted production would be more relevant to the oil rebalancing than an OPEC freeze.”

Leading investment bank Goldman Sachs, in a note released Monday, said the outlook in these three producers is the bigger factor going forward than whether OPEC and non-OPEC countries can agree to capping output in Algiers when an informal meeting will take place on the sidelines of the International Energy Forum. “Thawing relationships between parties in conflict in areas of disrupted production would be more relevant to the oil rebalancing than an OPEC freeze which would leave production at record highs and could prove counter-productive if it supported prices further and incentivized activity elsewhere,” wrote Goldman analysts.

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Positive supply developments

The three beleaguered OPEC countries have seen positive signs within the past week or so. Flows from northern fields controlled by Baghdad have resumed on Kurdistan’s pipelines to Ceyhan, while Iraq has also agreed to new contract terms with oil majors to increase its production in the south by as much as 350,000 b/d in 2017. A vessel at the Zueitina port in Libya, recently reopened, started loading crude. In Nigeria, the Niger Delta Avengers, which have knocked production offline, announced a ceasefire agreement.

While the situations in all three countries have improved, they are still precarious, putting supply recoveries in doubt. In Iraq, the tension between Baghdad and the Kurds still looms large, possibly hurting any thaw in tensions between the two. In Libya, where internal strife could hold back progress on increasing exports, local tribes are opposing any increase in production near the Zueitina port. Meanwhile, the Niger Delta Avengers made it clear they could reignite violence at any time.

“Nonetheless, these latest developments are the most tangible since headlines of higher production from these countries started to intensify over the past two months with crude oil physically moving,” said Goldman analysts, who note that the increases could tilt the oil market back into a surplus. Goldman, in previous estimates, had forecast a 230,000 b/d deficit during the second half of 2016.

If the OPEC trio being hampered by outages can increase supply by 500,000 b/d more than expected in 2017, Goldman would slice its price forecast by more than $7 for next year to $45 per barrel.

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Goldman emphasized the argument that many analysts have said since the bull market began in early August—talk about a production freeze has been the main impetus behind the rally. “We believe this move has not been driven by incrementally better oil fundamentals, but instead by headlines around a potential output freeze as well as a sharp weakening of the dollar (and exacerbated by a sharp reversal in net speculative positions),” said Goldman analysts.

“This move has not been driven by incrementally better oil fundamentals, but instead by headlines around a potential output freeze as well as a sharp weakening of the dollar.”

A production freeze is possible at the Algiers event, given that there has been a change of leadership in the Kingdom’s energy ministry. But the probability is low, as Russia has said publicly there is no appetite for capping output now. Moreover, the fight between the Saudis and Iran for market share is spurring doubts about any deal, and any price increase from a freeze would undermine the cartel’s long-term aims since a stronger market would improve the outlook for U.S. shale. Goldman also points out the irony of talk of a production freeze being bullish—the group would still be pumping at record levels, a bearish signal. The market may still have a long way to go until it has fully rebalanced and sees a sustained price rally.

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