OPEC agrees to increase output

OPEC agreed to a modest lift in output of 1,000,000 barrels per day (B/D) at the 7th OPEC International Seminar in Vienna. Further inspection reveals that the actual increase will be approximately 700,000 (B/D) due to capacity constraints, as some member countries don't have the means to produce more oil. Traders will note that the delta of 300,000 (B/D) will be significant in real terms. Although the communique was opaque, Russia's vocal support in combination with the Saudi pledging a measurable output boost, clearly outline their support and solidarity of OPEC even during fractious times.

However, the summit should be viewed as a success. Bear in mind that a number of experts doubted that the coalition of OPEC and non-OPEC members would maintain the accord. Effectively, compliance was reduced back to 100%, dropping production to previous levels. This caused some critics to question reports of increases because technically there wasn’t an increase to higher levels--more precisely production levels were less reduced. Investors should note that some members exceeded their compliance quotas to more rapidly absorb excess capacity.  

The conference marked the second anniversary of the initial agreement that reduced production by 2%, or approximately 1.8M (B/D). It is worth noting that pundits were initially skeptical that compliance would be obtained since it meant foregoing revenue. A number of experts gave OPEC leadership very little credibility to maintain production cuts. The maintaining and exceeding of compliance gained the organization extensive credibility.

The person responsible for orchestrating and maintaining the historic deal is OPEC's Secretary General Mohammad Sansui Barkindo. Perpetually calm and diplomatic, Barkindo is a combination of respectful and reflective. He selflessly always describes the deal as a team effort and eschews any personal credit. The Secretary General began the summit with optimistic comments and a matching disposition as he was peppered with questions from the media on the possible defection of Iran and Russia. There was speculation before the conference convened that Iran would leave in haste, due to anger at the Trump Administration's sanctions and perceived unfairness. Despite the intense meetings, Barkindo remained sanguine and confidently assured a reporter that the conference would be successful. When pressed he further stated that the event would climax with a party to celebrate the historic deal despite grievances and being mired in politics. Pundits expected machinations by Russia and protestations by Iran of mistreatment to unwind solidarity. Further complicating matters, Trump implored OPEC to produce more oil and tweeted his desire for lower prices. This only served to further enrage the Iran’s energy minister who reportedly stormed out previously.

The big winners at the conference are Saudi Arabia, Russia and Trump for the following reasons: 1) Saudi wants higher prices to aid budget management and assist the flotation of Aramco; 2) Russia will optimize sales; 3) Trump wants lower prices to bolster the economy and to aid Republicans during the midterm elections. 

Due to the success of the production cut strategy, oil prices dramatically increased. WTI is now at its highest price since November 2016, giving the entire energy sector strength that is augmented by fiscal discipline. As a result, upstream E&P equities will be amongst the strongest performers; we can also expect the Permian to perform well and continue to grow. 

We are in peak demand season, so spare capacity will more than likely be consumed quickly. Due to this tightening, prices can go considerably higher--most likely exceeding $80 B/D in the near term. 

Expect energy equities to gain in all areas along with their respective services in the near term. The entire sector will flourish as the beneficiary of higher oil prices. 
 

This elimination of capacity will serve as the basis for a high price spike as we approach IMO 2020 initiatives. These measures will serve to dramatically increase prices to demand destruction levels as the capacity in shipping is greatly reduced.

 

About the Author

Shawn Baldwin is Chairman of the AIA Group, an advisory firm. Prior, Baldwin built investment banking firm Capital Management Group (CMG). CMG participated in $68b capital markets transactions for the NYSE, the Chicago Mercantile Exchange and Google.