Our Analytics 9 november — 12:55

Everyone wants expensive oil now (Our analysis)

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BY DMITRY DOKUCHAYEV

Until quite recently it seemed that the extension of the agreement on the reduction of oil production was beneficial to all its participants, including Russia and Azerbaijan.

And suddenly, with the beginning of November, the number of doubters began to grow imperceptibly. Given that the commodity market has come to a kind of finish line, leading to the next OPEC summit, which will be held on November 30.

Saudis say 'yes,' but it's not enough

It is there, in Vienna, that will be decided whether the OPEC+ agreement concluded the year before is renewed, first by the 13 member countries of the oil cartel, and then by the 11 oil-producing states that joined them.

Participants in the deal agreed to voluntarily limit the extraction of oil in order to remove from the market the excess supply over demand and thereby support the price rate of the barrel, ready at any time again to collapse. And, one must say that the oil market is rolling to this finish line in a much better position than the year before. The cost of 'black gold' by November 2017 has exceeded $60 per barrel (for the first time since July 2015), and it seems that it is not going to stop in growth. Oil producing countries, including the active participants in the OPEC+ agreement, Russia and Azerbaijan, seem to be relieved. But not everything is as simple as it seems at first glance.

After the OPEC+ agreement was signed a year ago, the participant states really tried not to let anyone down and fulfil their obligations. The market appreciated this, having risen somewhere around $10 per barrel in 2017. And in November 2017, growth was even stronger, and we are already seeing oil at $60 or more per barrel.

Why? First of all, because of optimistic expectations. Most experts considered the recent announcement by Saudi Arabia's Crown Prince Mohammad bin Salman bin Abdulaziz Al Saud to support the extension of the OPEC+ agreement at the upcoming summit of the cartel in late November the main news that positively influenced the prices. He did not specify for how long the deal could be prolonged. However, the market concluded that this decision will be supported by other participants of the Organisation of Petroleum Exporting Countries. Russia, which continuously and unsuccessfully challenges the Saudi lead in terms of production, is also prepared to support the extension of the deal, Russian Energy Minister Alexander Novak said. All these statements gave rise to a wave of optimism in the market, which threw the price of the barrel higher.

Americans' move

Another important reason was the reduction in the number of shale drilling rigs in the United States. This trend has been going on for a month. In addition, the last one and a half months in the US has been seeing reduction in oil reserves: on average 1 million barrels per day. According to analysts, at this rate by the end of the year the US reserves could drop by another 70 million barrels. Recall that it was the factor of American shale oil that was the main brake for the OPEC+ agreement.

After all, the United States did not initially join this agreement, and so, could unlimitedly increase production. But, as the above statistics show, today the US shale threat is also neutralised. An additional factor in the rise in the price level of 'black gold' is the unstable situation in the Middle East. Of course, it is inappropriate to rejoice at the escalation of the political situation and the military exacerbations that are fraught with human sacrifices. But this does not cancel the fact that geopolitics objectively works to increase the price of a barrel, no matter how cynically it sounds...

One way or another, the current situation is at hand for all the producers of 'black gold,' who are vitally interested in favourable pricing conditions. According to OPEC Secretary General Mohammad Barkindo, in 2015-2016 the countries of the cartel lost more than $1 trillion due to low oil prices. Repetition of this bitter experience can turn into a financial nightmare.

When it is profitable for all

Including Saudi Arabia, which in 2018 plans to privatise 5% of the national company Saudi Aramco. Riyadh expects to raise $100 billion on this deal, which the Saudi authorities urgently need to plug huge holes in the kingdom's budget that have been formed over the past two years. And it is possible to reach such figures only under condition of rather high (and at the same time growing) prices for oil: therefore it obviously does not make sense to the Saudis to play on reduction of a barrel.

And for countries such as Venezuela, the drop in oil quotations threatens to turn into an economic catastrophe. The country is in the deepest economic crisis. According to the IMF forecast, in 2017, inflation in Venezuela will be 720%, and in 2018 may even reach 2000%.

Both Russia and Azerbaijan in 2015-2016 have also experienced serious economic problems, which is not surprising: both the budgets and the economies in general of our countries largely depend on the influx of petrodollars. Low oil prices are absolutely contraindicated to us, no matter how the authorities of our states try to diversify their economies and remove them from the 'oil needle.' It's a long and complicated business, but people need to live here and now...

What do we have at the output? Apparently, in the new reality prices above $60 are normal. The OPEC+ agreement is being successfully implemented: the monitoring committee of the association stated that the participants of the deal brought its terms implementation to 120%, which became the highest level since the beginning of the memorandum coming into force.

As for Russia, according to experts, the prices of $55-60 will allow to earn at least 1 trillion roubles a year. The forecasts for Azerbaijan are also optimistic.

The world supports oil

Proceeding from the outlined trend of strengthening the world demand for 'black gold' and reducing its stock in the US, many investors confidently predict that next year, Brent oil prices will hold in the region of $60-65. Of course, provided that the OPEC+ deal will be safely extended.

But there is also a certain danger. If the deal is suddenly not prolonged or it is limited to some close date, the market may be disappointed, and this threatens a new collapse of the barrel. Again, the threat to the market from shale mining in the US has not completely disappeared. American companies have drilled a number of wells that have not yet been launched, but in the event of commissioning, they will lead to a sharp increase in production. And this can happen if the prices for 'black gold' go up, again making shale mining profitable.

And yet, these risk factors clearly do not outweigh the positive that is associated with the OPEC+ agreement. All factors indicate that this deal to reduce oil production will be quite durable, says Michael Lynch, head of the Centre for Strategic, Energy and Economic Research (SEER). 'Now we can observe the most balanced market since 2014,' the international expert motivates his position.

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