OPEC: A Deal Still Likely, Probably

Published on December 6, 2018
SGH Insight
We think an output cut agreement will still fall into place by the end of the day on Friday. The final headline number for the size of the targeted cuts is likely to reach at least one million bpd, with a decent probability of a 1.2 million bpd cut that is being pressed by Saudi Arabia (SGH 9/26/18, “Oil: The Saudi Two-Stage Floor Strategy”). Assuming they get the blessing from Putin, the Saudis will press the case the cuts are to stabilize crude prices, not to spark a rally, in the hopes that pitch will be enough to stem a renewed tweet storm from President Trump.
Market Validation
(Bloomberg 12/7/18)
OPEC Meeting Ends W/ Deal on 1.2Million B/D OPEC+ Cut: Delegates

European Stocks Extend Gains on OPEC Deal, After U.S. Payrolls
By Ksenia Galouchko
Stoxx Europe 600 Index extends gains to 1.5% after OPEC meeting ends with agreement on 1.2m bbls/day OPEC+ cut.
Biggest gainers include Nestle +2.3%, Shell +4%, BP +3.8%, Total +2.7% Brent oil is up 5%

With the fate of Saudi Arabia’s hard line case for shared output cuts by the OPEC and non-OPEC oil producers hanging in the balance, Russian Energy Minister Alexander Novak left Vienna for St. Petersburg for a quick meeting with Russian President Vladimir Putin, promising to come back, not tonight, but still in time for tomorrow’s high stakes OPEC meeting with the non-OPEC oil producers.

*** We think an output cut agreement will still fall into place by the end of the day on Friday. The final headline number for the size of the targeted cuts is likely to reach at least one million bpd, with a decent probability of a 1.2 million bpd cut that is being pressed by Saudi Arabia (SGH 9/26/18, “Oil: The Saudi Two-Stage Floor Strategy”). Assuming they get the blessing from Putin, the Saudis will press the case the cuts are to stabilize crude prices, not to spark a rally, in the hopes that pitch will be enough to stem a renewed tweet storm from President Trump. ***

*** We would be remiss not to acknowledge the OPEC negotiations are immensely complicated by the cross-currents of US-Saudi relations that are under such enormous strain. There is a tail risk of a smaller cut or no cut at all for that matter. But we think that if that should be the headline by the weekend, the Kingdom will still push ahead with a second round of real cuts no later than February when more would be known on the Iran sanctions and waivers etc., as well as global crude demand next year. ***

*** Whether tomorrow or by February, Saudi Arabia will be forced to contribute the lion’s share of the cuts that would start in January, probably as much as 700,000 to 800,000 bpd. With Kuwait and the UAE contributing as much as another 350,000 bpd, the rest will have to come from the rest of the OPEC and non-OPEC countries, including Russia. Whether the non-Gulf producers cuts are real or not will color oil prices through the turn of the year into the second quarter. ***

Weakened Saudi Leverage

It is a stunning development that the Saudi-led negotiations within OPEC have come to a grinding halt until the deal receives Putin’s personal endorsement support, presumably including at least some semblance of Russian participation in the cuts. It is an enormous political victory for Moscow in its long sought dominant role in dictating the terms of future coordinated changes in the non-shale crude oil markets.

We do think the Russians will announce their limited participation in the cuts, ceding more than the 150,000 bpd or so already hinted at. perhaps as much as 250,000 or even the 300,000 bpd in cuts put to them by the Saudis. But it doesn’t really matter; the Russian cuts will again be lagged, building up to whatever number they agree to by the end of what is likely to be a six-month commitment. But it is likely to be face-saving enough for the Saudis to commit to their real barrel cuts.

The mostly negative headlines today were mostly about the Saudi delegation led by Energy Minister Khaled al-Falih “setting up for failure” to drive crude prices down enough to truly scare the other OPEC delegates. The Saudis have so far pressed hard on the terms to any deal built around their own deep cuts, namely that the others had to commit to real barrels cuts and the Russians most of all had to cut by at least 300,000 if not more. The threat, in an echo of the November 2014 breakdown, is no deal by the weekend with prices falling accordingly, probably through the $50 mark.

As scarring as the memories of the last oil price plunge in 2015 may be, the Saudi hard line negotiating tact is proving to be far less effective than it could have been. For one, at least with the Russians, they are insisting they are quite happy with $60 oil, which is positively crushing for most of the other oil producers, including the Saudis who are seeking a floor at $60, and prefer a price average closer to $70 if not higher to cover their increased budget spending.

A New Hook to the OPEC Negotiations

An almost equal factor complicating the output negotiations is the resentment across the rest of the OPEC delegations towards the Saudis for their apparent abandonment of OPEC to align with the US demands for an output surge to offset the sanctions pressure aimed at Iran — a founding member of OPEC.

But even more damaging to the Saudis was the seriously bad optics in the surprise appearance in Vienna of US State Department’s Brian Hook, who is overseeing the Iranian sanctions. The Saudis initially tried to deny they met with him, but too many press members and delegates saw him leaving their hotel. Worse, a State Department spokesman traveling with Hook confirmed the meeting to reporters even as the Saudis were denying any such meeting.

That Hook did not even bother to be discreet was telling, and is probably a far more powerful impact on the Saudis in limiting the odds for output cuts that the tweet storm from the White House.

But while it is proving to be quite humiliating for the Saudis, we think their revenue needs and the political standing of the besieged Crown Prince Mohammed Bin Salman with the other senior Al Saud princes translates into the Kingdom nevertheless pressing ahead with proposed cuts, and needing the blessing of their Russian ally even more, a development that seems lost on the Americans.

Back to list