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TACTICAL ACTIONS

Oil market remains stained but forecasts are optimistic

Author:

15.01.2019

This year started with an active price increase in the oil market since December 2016. Prices of Brent Crude and WTI (with delivery in February) for March 2019 increased by 3.4%, or $57.85 and $48.69 per barrel, respectively. In the first days of 2019, Brent rose by 10.8%, while WTI - by 7.4%, which have been the fastest growing rates since June last year. The main factors contributing to this growth were oil production cut in Saudi Arabia and Libya, forecasted decrease in the US oil reserves and optimism about the trade negotiations between Washington and Beijing, which could decrease tensions between the two largest economies in the world.

 

Towards stable prices

In general, the oil market remains strained amidst the signals of the weakening growth of the Chinese economy and the worsening prospects for the world economy. Nevertheless, the new deal to reduce oil production in OPEC+ countries, which became effective on January 1, may push oil prices up. OPEC member states and a number of non-member states have recently agreed to take 1.2 million barrels (800,000 barrels – OPEC, 400,000 barrels – OPEC+) off the oil market from October 2018. However, this decision did not change the situation until the end of December. Since the day of signing of the deal (December 7), the oil market has experienced several collapses. On December 24, quotes for Brent Crude dropped to a record $50.5 per barrel for the first time since July 2017.

Nevertheless, it is highly likely that the actual oil cut by OPEC+ will have a tangible effect and bring some stability to the oil market. "Traders believe that there may be a reduction in oil consumption. OPEC member states and major members of OPEC+ are expected to take active measures to stabilise the situation in 1Q2019, which is going to stabilise the oil prices," the Kazakh Minister of Energy Kanat Bozumbayev said.

Minister added said that in January, OPEC+ would make a statement to support the market. "This may be a statement that the parties will remain strictly committed to their obligations. It is also a matter of trust to the deal reached on December 7, because it affects the mood of traders," Bozumbayev explained.

Initially, it was announced that each of the member states in OPEC and OPEC+ would cut the production by 2.5% and 2%, respectively. However, in the third decade of December, interesting details of the agreement were revealed. In general, twenty four members of OPEC+ agreed to cut oil production by 2.65% from October 2018 during the first half of 2019, while all members of OPEC reduce production by 3%. Non-member states agreed to cut the production by no less than 2%, with Azerbaijan and Oman by 2.5% each.

For most countries, reduction of oil production is calculated based on the volumes of Oct 2018, with the exception of Kuwait and Azerbaijan (the countdown will begin from September), as well as Kazakhstan, which will cut production from Nov 2018.

Azerbaijan will reduce production by 20,000 bpd, to 776,000 bpd, although initially it was expected to decrease the production volume to 763,000 bpd based on the figures of Oct 2018. Despite this adjustment, Azerbaijan is fully committed to this obligation, for the country has always fulfilled its obligations for the last two years passing since the day of signing of the OPEC+ deal.

The largest cuts in production under the OPEC+ agreement will take place in Russia, Saudi Arabia, Iraq, the UAE and Kuwait. At the same time, Russia will have to cut production by 230,000 bpd, to 11.191m bpd. Russian Minister of Energy Alexander Novak said that his country would be able to achieve this indicator in 1Q2019.

 

The deal will be extended

It is too early to draw conclusions regarding the effectiveness of the OPEC deal. In February-March, 2019, it is planned to hold a meeting of the Joint Monitoring Committee of OPEC and OPEC+ in Baku to discuss the situation on the oil market and the measures necessary to restore the balance achieved last summer. The exact date of the meeting will be agreed.

In April 2019, OPEC+ member states will meet again to re-evaluate the situation and make the necessary adjustments to the deal. Nevertheless, some experts believe that the continuation will not follow.

On the contrary, Saudi Arabian Minister of Energy Khalid al-Falih strongly believes that the OPEC+ deal will be extended, because OPEC+ members need more time to achieve effective results balancing the oil market. "We will meet in April, and I’m sure that we will extend it. OPEC+ deal will make it possible to achieve a balance in the oil market in 2019," Bloomberg quoted al-Falih.

Analysts of Rystad Energy agree with al-Falih that the OPEC+ deal should be extended until the end of 2019, since production cuts by 1.2 million barrels per day will not be enough to ensure a stable and immediate recovery in oil prices. "OPEC production should remain at 700,000 bpd below the agreed target of 31.8m bpd until the end of 2019 to restore the balance in the market and return the quotes to $70 per barrel," the Rystad Energy report says.

Ed Morse of Citigroup believes that OPEC+ will be forced to cut production regularly because of the United States. "OPEC+ deal will reduce the oil reserves and increase the oil prices, which will eventually push the US and other countries to increase the production. This will increase the reserves, and OPEC+ members will come together again to readdress the issue. This situation will repeat from time to time," Morse believes. He added that the US would begin to increase production and exports when prices reach $70-75 per barrel.

According to the Russian Minister of Energy, the impact of the new OPEC+ agreement on the global oil market can be assessed no earlier than Jan-Feb 2019. Speaking about the effectiveness of the deal, he pointed out that in the last two years, Russia has earned additional $120 billion."

Mr. Novak, like his Saudi counterpart, believes that the cooperation of oil-producing countries will continue in any case, since the agreement "has proved its effectiveness", although it is difficult to predict its validity for the time being. "The price of oil will drop significantly if you release the production, allowing countries to fully use their potential," Novak pointed out.

 

Economy + Politics

It is not planned to establish a separate organisation for cooperation between OPEC and OPEC+ members, as the joint actions will be limited to the adoption of a voluntary charter. The document is almost ready with some nuances needing clarification.

"The declaration will describe the mechanism of interaction between the member states as to how we come together, discuss and adopt joint memorandums and resolutions. Joining us is a voluntary act – if one joins and agrees on the terms of a deal, then we can work together. If not, he is free not to be a party to the deal. This is sort of a public informal organisation", Novak explained.

In fact, the establishment of a new organisation of oil-producing countries may seriously weaken and even collapse OPEC, which is attacked by external opponents systematically, and political contradictions between the members states are constantly growing.

A major blow to the image of the cartel was the withdrawal from OPEC of Qatar, which explained this move with an intention to focus on gas projects. Given the nature of relations between Doha and Riyadh, the decision of Qatar to leave the cartel, where the Saudis have a clear lead, is quite natural and by no means a surprise. In this situation, the departure of Qatar would happen sooner or later.

"Our intention to focus on gas or oil production (of course, we are mainly a gas producing country) was not the only reason to leave OPEC. The other reason was that OPEC is gradually becoming a tool in the hands of a small group of countries, although it should serve the interests of all its members equally," Ambassador of Qatar to Russia Fahad bin Mohammed al-Attiyah said. He also noted that "OPEC is becoming a politicised organisation" manifested, for example, by the recent fall in oil prices. "I would not rule out the connection between the fall of oil prices and the murder of Jamal Khashoggi. The Saudis could provoke this fall in favour of the Americans, especially President Trump… Our share in OPEC was the smallest, roughly 650,000 barrels. At the same time, we are the largest producer of liquefied natural gas in the world, and this is where we will focus our efforts, as was stated by our Minister of Energy Saad al-Kaabi," the ambassador said.

Qatar’s withdrawal from OPEC did not have a major impact on the oil market, given the country's modest contribution to the overall production of the cartel. However, Qatar may be followed by others whose interests do not go in line with the decisions of the organisation. However, according to experts, the likelihood of major oil producers such as Iran or Iraq leaving the cartel is not high in the near future. Together, the OPEC member states make it easier to influence the market.

 

Predicting unpredictable

As for the future of oil prices, according to the experience of recent years, it is impossible to predict the unpredictable, especially for the coming year for a commodity whose exchange value can jump or fall instantly following an escalation of tension in a particular region or the statements of political leaders.

Yet, according to thirteen representatives of investment banks who participated in the survey, in 2019 Brent Crude will cost an average of just over $69 a barrel, while North American WTI will cost just over $63 a barrel.

Jefferies analysts expect Brent Crude to cost $65.75 per barrel on average, WTI $56.75 per barrel. Citi predicts the average price for Brent Crude in 2019 at $60 per barrel, WTI – $49 per barrel.

UBS experts predict that the Brent Crude in 2019 will sale for $70-80 per barrel, thanks to the OPEC+ agreements. The forecast is based on the fact that the largest producing countries have sent a "strong signal", having committed themselves to ensuring a balance in the global market. At the same time, the supply of oil in 2019 may decline, as production in Iran and Venezuela is likely to continue to decline in the coming months.

According Standard Chartered, OPEC production in January will reach 31.7m bpd, and any further reduction in production in Iran and Venezuela in 2019 is likely to shift the market from a moderate surplus to a moderate deficit.

"2019 for the oil market will be no less difficult than 2018, given that the world economy is losing growth rates, which may weaken demand," said Eugen Weinberg, head of the Commodity Market Research Department at Commerzbank AG. However, he believes that in 2019, OPEC+ will still be able to restore the balance of supply and demand in the oil market.

"The combination of OPEC+ cuts, restrictions on oil production in Canada and further reduction of Iranian exports due to sanctions should be enough to return reserves in developed countries to below five years' average," says oil analyst from Jefferies, Jason Gammel.

In general, the forecasts are not pessimistic, and in many respects even rather positive for oil-producing countries, including Azerbaijan. But to what extent they will materialise given the unpredictability of the oil market, we will see.



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