Our Analytics 8 december — 16:15

Sleep peacefully, oil will not collapse! (Our analysis)

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BY DMITRY DOKUCHAYEV

Sensation did not happen: OPEC countries, Russia, Azerbaijan and other independent oil producers agreed to limit the extraction of 'black gold' until the end of 2018. The exit from the now legendary OPEC+ deal is not yet being discussed: this is good news for the market. However, the oil market itself is such that the risks on it remain always, even when it seems that stability is achieved for a year ahead.

Azerbaijan: the extension of the agreement is expedient

Recall that earlier the current format of the deal was supposed to expire in March 2018. The oil summit of OPEC member-countries and a dozen other oil-producing states that are not members of the cartel (OPEC+), which was just held in Vienna, decided to prolong the agreement on limiting oil production until the end of next year. In addition, it was announced that OPEC members Libya and Nigeria, which previously were exempt (due to political events and natural disasters) from the obligation to reduce production, agreed to join the deal in 2018.

In total, 24 countries participating in the deal control about 60% of global oil production, and they pledged to reduce the global supply by about 1.8 million barrels per day, or about 2%. At the same time, the quota for a general reduction in oil production by all parties to the deal will remain at the current level.

How can we evaluate the reached agreement on the prolongation of the deal? First of all, as expected, most observers did not doubt such an outcome of the summit in Vienna. And this means that the global oil market has acquired a kind of an 'anchor' for a whole year ahead. Stock exchange players received an unambiguous signal that excess oil volumes will not 'hang' over the market in the next 12 months, threatening to crash the barrel. Actually, for this purpose, the very agreement OPEC+ was started.

It can be said that the agreement on the prolongation of this deal was reached at a critical moment for the oil industry, which has been in an unstable recovery for the last year. The reduction in production by the participants of the memorandum, along with the acceleration of world economic growth and the increase in geopolitical tensions in the Middle East, contribute to higher prices.

'We are still very far from achieving the ultimate goal,' said Russian Minister of Energy Alexander Novak. His Azerbaijani counterpart, Parviz Shahbazov considers the extension of the agreement to be expedient, as well as maintaining quotas for production at the same level. For Azerbaijan, the reduction obligations are set at 35,000 barrels per day.

Azerbaijan's Minister of Energy Parviz Shahbazov

Saudi-Russian compromise

Of course, the deal could not have taken place without active participation of all 24 countries that had signed the memorandum. But Saudi Arabia and Russia played a key role in reaching the agreement, if only because these countries are absolute world leaders in terms of output (during the shale heyday the US is approaching them), and they also account for the largest volume of cuts. In addition, the Saudis are the original leaders of OPEC, and the Russians of the rest, participants in the deal not part of the cartel. So, the agreement reached is a sign that the new oil alliance of Saudi Arabia and Russia is strong enough to overcome differences both in terms of reduction and in terms of the agreement. These two countries were able to work out a viable compromise to protect their interests.

The Kingdom was able to achieve important success by insisting on the obligation to maintain quotas the whole next year. As Saudi Arabia hopes, the deal will ensure stable oil prices in 2018, for which is planned the IPO of the Saudi oil company Aramco.

The Saudis want to replenish their budget on this transaction by no less than USD 100 billion. And the market capitalisation of Aramco will largely depend on the cost of the barrel and the state of the global oil market.

The decision to re-examine the terms of the deal in June was a concession to Russia. Russian oil companies are interested in the limited nature of the deal with OPEC, which allows them to take advantage of higher prices, but not lose competition with US companies. Energy Minister Novak received assurances from major Russian oil companies that they would honour the agreements reached.

Where will the barrel swing?

The main question is what will now, after the extension of the OPEC+ agreement, be oil prices in 2018? Most of the forecasts are fairly calm. Virtually no one expects an explosive increase in the price of a barrel, nor its dramatic collapse. The overwhelming majority of analysts believe that the price for the whole next year will remain at the current level of plus or minus a couple of dollars, that is, around USD 63-65 per barrel. It is in this range that one sees a new equilibrium point that can satisfy the market in the next 12 months.

Pessimists, as, for example, experts of the World Bank, give forecasts in the range of USD 55 to 60, which is slightly lower than oil price today. Almost none of the serious experts and think tanks forecast less than USD 50 per barrel, which can already be considered an achievement for an extremely volatile oil market.

On the other hand, optimistic forecasters do not go up too much as well. They cautiously argue that with the expansion of the number of participants in the deal OPEC+ (a dozen more oil-producing countries closely monitor the process and even express ideas for joining the agreement) the road to the next important psychological mark may open: at USD 70 per barrel.

Why is the growth in the price of a barrel seem so modest: why not USD 80 or 100, as it was in the middle of 2014? The fact is that in the role of limiting the cost of oil, as before, will be American shale mining. As you know, the higher the price of a barrel, the more profitable it is, and if the price of oil approaches USD 70 per barrel, experts predict a rapid rise in American shale oil production.

And since the US is not involved in the OPEC+ agreement, their producers can increase production without any restrictions. And if this happens, then the barrel will again begin to be pressured by the surplus of oil; and the price, accordingly, will go down. But even if the price of a barrel without any rise is simply fixed for another 12 months at USD 60-65, this in principle suits Russia, which makes up its budget next year with a margin, based on the average annual forecast of oil prices of USD 50 per barrel.

That is, everything above this figure will turn into additional budget revenues, which experts estimate in the range from 1.2 trillion to 2.4 trillion roubles. Such money will clearly not be superfluous for the Russian Federation: real incomes of the population are falling and Russians are counting on all sorts of electoral 'gifts' in the year of presidential elections, not to mention the indexation of pensions and other social benefits laid down by law.

What's next?

The extension of the OPEC+ deal sparked a new wave of discussions and comments by experts. According to most analysts, OPEC and the coalition of oil-producing countries (such as Azerbaijan, Oman and Kazakhstan) that are not members of the cartel, led by Russia, was able to work out a strong solution. However, analysts add that the stable growth of the global economy, interruptions in production and geopolitical tensions in the Middle East and Venezuela are likely to affect prices no less than OPEC actions.

The oil-producing countries also announced that they could review the terms of the deal at the next meeting in June; Russia insisted on the same. Thus, earlier cancellation of production quotas is possible, if the coalition considers that price growth helps American shale companies at the expense of those countries that cut production.

Meanwhile, there are doubts in the market that the OPEC countries will follow the established quotas exactly. However, Saudi Energy Minister Al-Falih said that he personally will head a monitoring committee, which will control the implementation of the deal and ensure compliance with the requirements.

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