OPEC has limited scope for new round of cuts

Oil&Gas Materials 29 November 2019 10:38 (UTC +04:00)
OPEC has limited scope for new round of cuts

BAKU, Azerbaijan, Nov.29

By Leman Zeynalova – Trend:

OPEC has limited scope for new round of cuts, Trend reports citing Fitch Solutions Macro Research (a unit of Fitch Group).

“OPEC+ is in an unenviable position, struggling to prop up prices against weak demand growth, fragile market sentiment and strong gains in non-OPEC supply. Although it is hard to disentangle the different price drivers, it is our view that the actions taken by OPEC+ have put a floor under Brent and helped to prevent deeper relapses this year. That said, the price recovery has remained thin and – coupled with the sanctions in place on Venezuela and Iran – the group is now holding more than 3.5mn b/d of supply out of the market, loosely equivalent to three years’ of global demand growth. Over the last 12 months, expectations of a tighter market have triggered several rallies, but these have been necessarily limited, because any tightness is in effect artificial and ample supply can be rapidly returned,” said the company.

Effectively, Fitch Solutions believes that the OPEC+ production cut agreement is now capping the upside to prices as much as it is the downside, and so the OPEC put has become the OPEC collar.

“It is highly probable that the group will rollover the deal in its current form until at least the end of 2020, but we see limited scope for a new round of cuts. For one thing, the burden of the cuts has fallen highly unevenly, with Saudi Arabia bearing the brunt. The group faces a trade-off to be made between the decrease in revenue due to lower production and the increase in revenue due to higher prices. Patchy compliance will make consensus harder to reach, if there is reason to believe that the price impact from cuts made by one member of the group will be offset by a hike in output by another. That said, gains appear to have been fairly broad-based, despite widely different moves in production. Admittedly the calculation made here is extremely back-of-the-envelope, but it is nevertheless indicative,” said the company.

On the surface then, deeper cuts would seem an attractive option, offering a net gain in revenue, according to Fitch Solutions.

“With the group’s governments’ revenues on average heavily dependent on oil and with a number of these governments under severe fiscal s train, higher prices could offer needed relief. That said, there is likely some diminishing return to scale involved. The initial cuts were negotiated in a year when Brent averaged around $4 5.0 /bbl. With prices slumping to below $30.0 /bbl at the nadir, the market had clearly overs hot and participants were arguably receptive to a rebound,” reads the analysis.

With prices currently approaching the mid-60s, lingering concerns for demand and strong (albeit slowing) growth in US shale, it is probable that deeper cuts would be needed, to secure an equivalent gain in price, according to the company.

“Given their dominance in production, it is largely Saudi Arabia, its GCC allies and Russia that will decide the fate of the deal. These countries demand widely different prices to fiscally breakeven and Russia, which boasts among the lowest breakevens, has been showing increasing signs of frustration with the restraints imposed on it under the cut. In general these key producers have been tightening their spending and, in the case of the GCC, gradually growing the role that private capital plays in their economies. More importantly, they all boast large fiscal buffers, which alleviates the near-term pressures from lower prices. In light of this, of how much oil has been removed from the market already and of how sticky the cuts have proven so far, we do not believe a strong rationale exists for deeper cuts to be made.”


Follow the author on Twitter: @Lyaman_Zeyn