OPEC: Vital signs for oil prices – RBC CM

Research Team at RBC Capital Markets, suggests that OPEC’s decision to collectively cap output at 32.5 mb/d proves that the prolific pronouncements of OPEC’s demise were premature.

Key Quotes

“While the details of the 900 kb/d cut need to be determined, the move marks a major turn-around for Saudi Arabia and likely reflects the mounting economic challenges facing the Kingdom in the current price environment. Naysayers will undoubtedly fade the headline and deem the agreement typical OPEC noise, yet at a minimum it means that OPEC has bought themselves a price floor for the next couple of months.

On top of OPEC’s decision to collectively cap output at 32.5 mb/d last week, Saudi leadership announced plans to scale back public sector salaries and benefits, an especially controversial decision in a country where around two thirds work for the state. Earlier cuts in electricity, water, and energy subsidies have come under criticism on social media. In addition to imperiling the social contract that has underpinned stability, the low price environment is also suboptimal for the heavily publicized Aramco IPO and risks another sovereign credit downgrade as the country is poised for a $10-$15bln debt issuance. Hence, we believe it was key domestic considerations that caused the Kingdom to put aside its regional rivalry with Iran and pursue pragmatism. We also believe that Saudi Arabia will be pretty determined to make the deal stick as it has so much on the line and put so much diplomatic effort behind forging the consensus in Algiers.

Naysayers will undoubtedly fade the headline and deem the agreement typical OPEC noise, yet at a minimum it means that OPEC has bought themselves a price floor (for at least the next two months heading into the November meeting). While talk is cheap and execution is paramount, the reinstalling of a group quota system is a constructive outcome given that the lack of a quantifiable measure of accountability has proved elusive and plagued OPEC over recent years.

We estimate that current OPEC production sits some 900 kb/d higher (3-month average) than the newly minted output ceiling of 32.5 mb/d. Saudi Arabia will likely bear a significant portion of the cut (production typically tapers in the fall anyways alongside domestic demand) with the remainder distributed among the rest of the cartel. While prices rallied off the agreement, OPEC is not out of the woods and fiscally challenged countries like Nigeria and Venezuela have scope to continue to fall further.”