The OPEC+ deal could push oil prices back to $70 per barrel next year, assuming all goes according to plan.
The combination of raising the production cuts to 1.7 million barrels per day (mb/d), plus the unilateral over-compliance by Saudi Arabia, adding another 400,000 bpd of additional cuts, surprised the market last week. In addition, Saudi Arabia hopes to apply pressure to all member countries to comply with their allotted reductions. Oil prices jumped immediately after the deal was announced.
One of the questions was how the group would allocate the additional cuts. Here is a quick rundown of a few key figures:
- Saudi Arabia agreed to cut by another 167,000 bpd (while also including 400,000 in voluntary cuts)
- The UAE: 60,000 bpd
- Kuwait: 55,000 bpd
- Iraq: 50,000 bpd
- Russia: 70,000 bpd
There are smaller contributions from the rest of the group.
While the initial reaction was positive from a pricing perspective, the reactions have since become more mixed. According to Bank of America Merrill Lynch, the first quarter could still see a surplus of 700,000 bpd. High compliance with the cuts would only slash that surplus by 200,000 bpd. The bank was skeptical that all producers would comply, with Iraq a particular focus.
Julian Lee over at Bloomberg Opinion pointed out that Saudi Arabia has really staked its credibility on this deal, and it will either succeed in getting all producers to comply with the deal, or else Riyadh may decide to flood the market when the deal expires in March.
Bank of America also had an eye on this risk factor. “If other members are producing egregiously above their targets, Saudi may opt to boost output to its agreed quota levels,” Bank of America Merrill Lynch wrote in a note. But if everyone works out, OPEC+ might be able to claim some degree of success. “Strong compliance, coupled with other positive economic developments, such as a pick-up in global inventory restocking and a small US-China trade deal, could push Brent to our $70 price target ahead of schedule.”
Goldman Sachs revised up its Brent price for 2020 to only $63 per barrel, up from $60 previously, with supply-demand numbers largely in balance. The bank said that the deal would likely increase the backwardation in the futures curve.
Others largely shrugged at the deal, pointing out that actual production levels from OPEC+ aren’t all that different from the announced numbers. “We expect most participants to abide by their new commitments and will adjust the countries’ economic forecasts accordingly. However, the overall impact on price is likely to be limited – with the agreement doing more to redistribute the existing cutting burden than to alter actual absolute production by the 24 adherents,” Pat Thaker, Editorial and Regional Director, MEA at The Economist Intelligence Unit, said in a statement.
Raymond James was more supportive of the market outlook. The bank sees WTI averaging $65 per barrel in 2020 and Brent averaging $70. But it sees the upward trajectory accelerating into 2021, with WTI averaging $75 and Brent averaging $80. “To underscore, all of these forecasts are still well above consensus and futures strip pricing, so we remain emphatically in the bullish camp on oil,” Raymond James said in a note on December 9.
Much depends on the reaction from U.S. shale. Rystad Energy sees the industry continuing to grow.
Others are more skeptical that the deal actually throws a lifeline to U.S. shale. “This higher spot price forecast does not lead us to raise our 2020 US shale production growth forecast which remains at 600 kb/d. Poor financial performance, excess leverage and an increased focus on emissions have pushed the cost of capital of shale oil producers sharply higher, with this pressure no longer delivered by oil prices but by equity and debt markets,” Goldman Sachs analysts wrote in a note on December 6. “We therefore expect the recent shale restraint to persist even at moderately higher prices given it will take years to clean up the debt, capacity and emissions excesses.”
In other words, the U.S. shale industry, in the aggregate, has still not demonstrated its ability to produce any profit. Any positive cash flow from individual companies will mostly be diverted into debt reduction or shareholder payouts, rather than ratcheting up drilling, Goldman said. The whole sector has seen an increase in the cost of capital as investors grow wary.
However, the bank cautioned that there is a limit to this dynamic. If oil prices rose above $60 per barrel, the returns could improve for shale companies, at which point maybe they would in fact return to drilling. As such, the “too tight physical market would once again undermine the OPEC+ cuts.”