OPEC tries to prevent an oil price spike

Market Update, Multi Asset 6/25/2018
Reading time: 2 minute(s)
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  1. As widely expected, the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC member Russia have announced plans to increase production volume over the next six months.
  2. The planned ramp-up by 1 million barrels per day (mbpd) until the end of this year, though not supported by some countries (Iran and Iraq), shows the leading oil producers want to prevent an undersupply.
  3. While the decision indicates the cooperation between OPEC and Russia will continue, it is problematic for the organization. Only a few countries like Saudi Arabia, Kuwait, the United Arab Emirates and Iraq can actually increase production from current levels. Other nations will now lose global market share. Therefore, this increase brings OPEC spare capacity to even lower levels and limits its room to maneuver.

Why did OPEC change its mind?

Since OPEC’s November 2016 decision to rebalance the oil market – when global inventory levels were at record highs (see chart 1) – the organization has cut output, producing even less than intended. As a result, stock levels fell below the five-year average and oil prices surged towards 80 U.S. dollar this spring, increasingly burdening consumers all over the world. OPEC therefore realized it was time to revise the agreement, Twitter messages of U.S. President Donald Trump, a close ally of Saudi Arabia’s s Crown Price Mohammed bin Salman, calling for an end to price increases may have played a part. New U.S. economic sanctions against Iran, which will probably lower the country’s supply by 0.5 mbpd, are another reason why OPEC and Russia wanted to review its November 2016 decision.

Chart 1: OECD stocks back in normal territory

Source: EIA, Thomas Reuters, Vontobel

Where do oil prices go from here?

OPEC’s decision to increase production didn’t wrong-foot us. While the organization’s decision decreases the possibility of the oil price rising above 85 U.S. dollars, our main scenario of prices moving between 65 and 85 U.S. dollars remains in place. However, it is worth noting that the planned production increases also curtail OPEC’s spare capacity (see chart 2), resulting in a reduced ability to react in times of supply disruptions. These may occur in different parts of the world like Iran (U.S. sanctions), Venezuela (obsolete oil producing equipment and demotivated workforce), Libya, Nigeria (civil war) or even Canada (recent outage at oil sand production site). Such supply uncertainties should start a new oil investment cycle and support long-dated oil prices. This, in turn, should benefit our position in oil service and equipment stocks, which we recently increased. By the same token, we see upside potential for European oil stocks and Canadian stocks, which also benefit from oil prices above 65 U.S. dollars.

Chart 2: OPEC spare capacity will drop further

Source: EIA, Thomas Reuters, Vontobel