OPEC Details Production Cuts Which Still Imply A Glut

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Includes: BNO, DBO, DTO, OIL, OILK, OILX, OLEM, OLO, SCO, SZO, UCO, USL, USO
by: Robert Boslego
Summary

OPEC+ finally announced its detailed production cuts.

But OPEC's own forecast shows they are not enough.

OPEC's forecast implies a 264 million barrel build in 2019.

EIA's forecast shows builds of 68 million in 2019 and 75 million in 2020.

OPEC is in a no-win predicament.

OPEC finally released its list of voluntary production cuts for the first half of 2019, inclusive of non-OPEC producers. OPEC’s portion is about 800,000 b/d and the non-OPEC producers’ share is about 400,000 b/d, as announced December 7th.

Source: OPEC.

Initially, a decision had been made not to release country-by-country cuts. The group has become increasingly sensitive to President Trump’s accusations that OPEC is an 'illegal monopoly,' and antitrust laws in the U.S. and many other countries prohibit collusion, even if the stated goal is ‘price stabilization.’

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OPEC General Secretary Mohammed Barkindo. Source: OPEC.

For over a year, OPEC General Secretary Mohammed Barkindo has been trying to “institutionalize” the OPEC+ arrangement that includes Russia. And in the press release following the meeting with non-OPEC producers on December 7th, OPEC wrote:

The Meeting emphasized the support and commitment of all participating countries in the ‘Declaration of Cooperation’ to build on the success achieved thus far, through further institutionalizing the framework for regular and lasting cooperation under the draft Charter of Cooperation between Oil Producing Countries, which was endorsed in principle and to be finalized and ratified by the participating countries.” (emphasis added)

But Russian Energy Minister Alexander Novak said on December 28th that "(T)here is a consensus that there will be no such organization. That's because it requires additional bureaucratic brouhaha in relation to financing, cartel, with the U.S. side.” He was reportedly referring to the potential to expose non-OPEC producers to U.S. sanctions if they joined with the cartel.

Russian Energy Minister Alexander Novak.

Russian Energy Minister Alexander Novak. Source: Reuters.

No Quick Cut From Russia

Mr. Novak has said that his country cannot make the cut quickly for technical reasons. He reported that January’s production has dropped by about 30,000 b/d from the October baseline. He has also said that Russia will try to reach its 230,000 b/d cut within 1Q19.

The International Energy Agency has also expressed doubts about the strength of Russia's commitment to the cuts. In its January report, it wrote:

Data show that Russia increased crude oil production in December to a new record near 11.5 million barrels per day and it is unclear when it will cut and by how much... While Saudi Arabia is determined to protect its price aspirations by delivering substantial production cuts, there is less clarity with regard to its Russian partner."

The IEA expects "the journey to a balanced market will take time, and is more likely to be a marathon than a sprint." UAE's energy minister, and 2018 OPEC president, Suhail al-Mazroue, had predicted, "As we start a new year, I remain optimistic toward achieving the market balance during the first quarter after [the] OPEC and Non-OPEC production cut."

The Energy Information Administration "expects that during the first several months of 2019, Russia will gradually reduce production from record high levels reached during the fourth quarter of 2018... EIA then expects production growth in Russia to resume in the second half of 2019 and continue into 2020."

The EIA also expects production growth in Kazakhstan, one of the non-OPEC countries OPEC reports will reduce production. "EIA forecasts production to ramp up in 2019 to peak production levels at the Kashagan field."

Mr. Barkindo had written in a letter to the non-OPEC energy ministers in December:

I would urge Your Excellencies to kindly make positive announcements reinstating your countries’ commitment to implementing the agreed decisions. This is also vital to underpin trust in our decisions and to buttress ourselves from any naysayers who may doubt our commitment.”

I have not seen any announcements by other non-OPEC countries relative to their intentions to reduce their output.

OPEC's Own Balances

According to OPEC’s January Oil Market Report (OMR), OPEC forecasts an average “call” (demand) for OPEC oil of 30.825 million barrels per day (mmbd) for 2019.

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OPEC’s production in October, which serves as the base period for the 800,000 b/d cut, averaged 32.358 mmbd. If the cut is matched, production would average 31.558 mmbd in 2019.

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Given that production would exceed demand under OPEC’s own scenario by 733,000 b/d, global stocks would build 264 million barrels during the year, creating an immense glut. However, it is uncertain whether the OPEC+ cuts will be larger or smaller than the one announced. Production from Iran, Venezuela and Libya, three countries not included in the cut, could rise or fall, subtracting from or adding to the 1.2 million barrels.

A resolution to the Iran sanctions should also not be dismissed, given President Trump's penchant for deal-making. On the other hand, the sanctions may be strengthened in May and Venezuela's production could continue to decline.

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OPEC's scenario would tank prices once again, which in turn, with a lag, would discourage production growth for the year. Alternatively, OPEC would have to nearly double its 800,000 b/d cut to keep stocks from building in 2019.

In the meantime, the EIA reported that U.S. crude oil production had risen by 200,000 b/d for the week ending January 11th to 11.9 mmbd. I had expected an upward revision in the EIA’s weekly numbers because the October 914 monthly (actual) production report “was also 200,000 b/d higher than the 11.360 mmbd estimate for that month in the December Short-Term Outlook. That implies a potential upward revision to EIA’s model in future production levels.” (Quote from my post to Boslego Risk Services' members).

The EIA forecasts, in its January Short-Term Energy Outlook, that OECD stocks will build by 68 million barrels in 2019 and another 75 million barrels in 2020. EIA’s figures take into account the OPEC+ cuts.

Conclusions

OPEC is in a no-win predicament because of U.S. shale. If they cut to keep prices elevated, they encourage shale growth which replaces their cuts. If they do not cut more, inventories will swell and prices will tank as a result.

On December 18th, I declared "mission accomplished" as my position in SCO (double short crude ETF) reached my objective of $30.00, and I closed out my short crude position (read my article to see my trades in the 4th quarter of 2018 and the rationale given for each trade, proving they were not lucky guesses). I am awaiting the next catalyst which will send oil prices on another quick trip lower. Non-compliance by Russia and non-OPEC producers in January may be that new catalyst to be reported in a couple of weeks.

It's ironic that OPEC+ has to cut for a third year despite sanctions being imposed on Iran and that their cuts may still not prevent a glut from developing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.