"There's just no pleasing some people ......"

Thursday 1st December 2016

"There's just no pleasing some people ......"

ref:- "Hangover Awaits as OPEC Celebrates Its Biggest Accord in Years",  Bloomberg Markets

We can't help feeling that when they talk about people who just can't be pleased, they're including us amongst that number ..... Guilty as charged. No apologies though ..... a healthy dose of scepticism may be the legacy of too many years market-watching but is nevertheless an important element in the investor's armoury. Besides, playing the sceptic can be a lot more fun than following the herd .... you've just got to be careful that the search for hidden dangers doesn't blind you to obvious truths. That can be expensive, and mildly embarrassing.

So despite the less optimistic atmosphere witnessed on Monday and Tuesday, OPEC pulled it off. A deal to cut their own production to 32.5m bpd (about 1.2m bpd less than current levels) AND to rope in non-OPEC producers to reduce their own output by 600,000 bpd was right at the bullish end of expectations. Saudi Arabia will shoulder the biggest burden by cutting their production by nearly 500,000 bpd to a little over 10m bpd, while their close allies and confreres Kuwait, Qatar and the U.A.E. have each agreed reductions of about 200,000 bpd. Iraq will cut by 210,000 bpd to 4.35m bpd, while the Iranians will cap production at 3.8m bpd, about 90,000 bpd above current levels but some way below their previous target of nearly 4m bpd, Outside of OPEC, Russia has agreed to swallow half of the 600,000 bpd hit. The oil market celebrated the deal by pushing the price of crude up by more than 8%.

On the face of it the deal might seem like something of a climbdown by the Saudis after their powerful rhetoric of recent days. They might point out, perfectly reasonably as it happens, that as OPEC's largest producer it's only natural that they should wear the largest cut in output. Picking numbers out of the air, it also doesn't take a mathematical genius (anybody got one?) to work out that 10m barrels at $60 provides a lot more revenue than 10.5m barrels at $45, say. But it's inevitable that some will see Saudi's newly-accomodative stance as an indicator of the tougher financial climate facing the kingdom.

Frankly, that's not exactly news ..... austerity measures and a (successful) programme of bond issuance told us that. What the deal deal does confirm though is that the Saudi's pump-at-will policy to force out higher-cost producers and win back market share has failed. The collapse in prices brought on by that plan of action proved just too debilitating, even for a Saudi regime that back in 2014 must have thought it had more than enough ammunition to ride out a temporary lowering of the oil price.

OPEC and its acolytes are hailing the new accord as confirmation that the organisation is not only alive and well but has at a stroke restored its credibility. Er ..... hang on a minute. It's one thing to make a deal, but then you've got to stick to it (can you feel the scepticism on its way?). To be frank, the history of OPEC's production agreements does not inspire enormous confidence. Generally speaking, Saudi and its Gulf allies tend to stick to their promises but not all OPEC members have proved as reliable.

It's very difficult to monitor and police production quotas. It was highly instructive (and a little shocking) to hear Bloomberg's top oil man talking this morning about how in many cases "monitoring" was no more precise than counting the number of tankers coming out of harbour and estimating how much oil was being shipped by how low the ships sat in the water. Furthermore, there is little chance of a third party monitoring how much a producer is pumping down pipelines. In effect, that means that producers to a large degree have to be self-policing ..... and therein lies the problem. If past agreements are anything to go by, the temptation to fudge the numbers in the pursuit of much-needed revenue is too strong for some.

But assuming everyone plays the game for a moment, what might this deal mean for prices? Goldman Sachs, who had been pointing out that the markets were ascribing just a 30% probability of success at this meeting, are today suggesting the next stop for crude may be $60. For some time it's been a widely-held view that $60 is the level where shale oil producers really become a big factor again. Actually for many shale rigs it's a lot less than that, but the point is well made. We have to remember that OPEC now produces less than 40% of the world's oil, so a big spike in prices would likely be met by supply from outside OPEC even if those within it behaved themselves, and it may start some way ahead of $60. 

It's a huge irony that the fortunes of shale producers in particular may be resurrected by a deal amongst those who had so recently attempted to put them out of business. Nevertheless, that's the reality of it so without being too much like party-poopers we would urge a little caution. There are some very excited people running around energy markets just now. If this was the deal they've been waiting for we're happy for them, but looking further ahead ? Well, let's just say that it won't do any harm to keep a little scepticism up your sleeve.