Slightly more detail came out of the Algiers meeting yesterday. OPEC looks to target production of 32.5-33 million b/d. Now who will contribute to the production cut remains unknown, but there are currently reports saying Saudi and Qatar will jointly reduce production.
After the conclusion of the deal, similar to before the meeting, every sell side report we've read thus far is bearish on the deal. Morgan Stanley points to these output deals never turning out and with a number of firms providing evidence of historical deals never panning out. Goldman did not revert on its lower for longer call. Several Canadian banks point to a higher probability of $60 in 2017, but said that skepticism for implementation of the deal remains uncertain.
Despite the overwhelming consensus being bearish, oil (NYSEARCA:USO) ignored all skeptics and marches higher.
Oil prices are approaching our upper range of $42-$48, and we have now updated our price range to premium subscribers. The overly bearish sentiment post the meeting is a good sign. As long-term (1-3 years) oil bulls, we feel more comfortable if the consensus remains skeptical. It's much easier to find a variant perception than if everyone was bullish.
What we want to point out in today's OMD is one simple dynamic most people choose to ignore when assessing commodity markets. Fundamental is one variable to the equation and drives prices in the long run, but short-term movements are far more susceptible to emotions than most believe to be the case. Looking at our supply forecast for 2017, we see a market in deficit as the world won't be able to replace the declines coming out of non-OPEC countries and Venezuela.
We just received reports yesterday from oil traders familiar with the Venezuela situation showing that production for September dropped to 1.8 million b/d. The pace of the 100k b/d decline remains on pace, and we expect Venezuela to continue to decline.
While everyone's attention is on the outcome of the deal, very few are talking about the sentiment change being displayed by the Saudis yesterday. Their willingness now for much higher oil prices is a very evident turning point in this oil downturn. Sentiment should continue to shift from "overly bearish" to "slightly less bearish" resulting in oil prices approaching the $50 mark once again.
As for the actual implementation of the deal, we think the only real way to curb supplies is for Saudi and its Gulf allies to cut production. Other OPEC countries are producing at max capacity, so even if they wanted to cheat, they can't. Venezuela should continue to decline and its goal of growing production in 2017 is nothing but a pipe dream. Nigeria still faces issues with militants and as we've highlighted multiple times, militant payments are a form of maintenance capex.
Libya won't be able to grow production by a material amount as its oil fields are heavily damaged after five years of neglect. In order to restore even a sliver of its old production back, Libya will need to spend billions and billions of capex in newer fields and additional infrastructure would need to be built to support the recovering production. We have a hard time seeing Libya having that much money to put towards oil capex.
All in all, the Algiers meeting is boosting sentiment, but we don't expect material fundamental change to take place. Fundamentals are already pointing toward a more balanced market and suffering producers like Venezuela will continue to suffer regardless of a $10 bump in oil prices. Time is on the side of the oil bulls.
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