A few months ago, some investors speculated that Oil prices could reach $100 per barrel in 2018. Sanctions on Iran, shortages in supplies, strong demand, and an all-time low in spare capacity were all factors contributing to driving prices to new highs. This proved to be a bad speculation. After OPEC’s meeting in June, the cartel decided to ramp up production to meet any supply shortages. What happened next was the U.S. issuing eight countries for waivers before sanction on Iran kicks off, global demand seemed to have abated, and production in the U.S., Saudi Arabia, and the United Arab Emirates reached a new high. These factors combined led to a free fall in prices where Brent lost third of its value from October’s peak.
Today’s OPEC meeting is held at a very critical time where there’s clear evidence of a global economic slowdown and strong Oil supply particularly from the U.S. which will eventually lead to oversupply and swelling inventories.
The current environment requires a strong response and is definitely a case for cutting supply to save prices from falling further in 2019. While we think that a cut in production will be announced in Vienna today, the more critical question is by how much, and how the cartel would divide the cuts among members and non-members?
This is where it becomes tricky. Although Russia agreed in principle to cutting production, they do not feel the same urgency as the Saudis. That’s simply because Russia’s economy is more diversified and the Ruble is free floating. Higher revenues from a strong rally in Oil prices will be offset by a rising currency. A range of $50-$60 is just fine for Russia. Meanwhile, Saudi Arabia needs Oil price at $85 to balance its budget, according to the IMF.
Iraq is also under severe economic pressure and doesn’t want to cut production. If it was forced to, there’s an increasing chance of leaving the cartel eventually.
The base case scenario seems that Saudi Arabia will shoulder most of the burden with a symbolic cut from Russia.
OPEC are also aware that a high spike in Oil prices will attract more anger from the U.S. President. So, expect the cut to be anywhere between 1 – 1.5 million barrels per day from November’s level, and the situation will be reevaluated in 2019. Under this scenario, prices may remain range bound until year end.
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