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The 169th. Meeting of the OPEC Conference Vienna, 2nd. June, 2016

John Hall
: OPEC is resolute – policy is working, no change!

(L-R) OPEC Director of Research Division, Omar Abdul-Hamid, Qatari Minister of Energy and Industry Mohammed Bin Saleh Al-Sada, and President of the OPEC Conference, and OPEC Secretary General Libyan Abdalla Salem El- Badri.

In the run up to this meeting, we had the usual conjecture as to what would happen. Beforehand at registration, I met some of the Nigerian delegation and asked them what they though and they were very enthusiastic that a new Secretary General was going to be appointed.

Elsewhere, rumours were again leaked out that an output deal would be reached but the true reality had already been accepted by most of us, that OPEC would not deviate from the policy that it had set in 2014 by which it would maintain output levels irrespective of price. So, why did over three hundred journalists and analysists and film crews book themselves in to attend, but many did not turn up. We all have views and think we know, but, we can never be sure. We follow and hang on to “fundamentals” and “technicals” and then we have OPEC which can often be depended on to do something different and that is why there is always so much interest.

One key factor beforehand was the unexpected replacing of Ali al-Naimi the veteran Saudi Oil Minister by Khalid al-Falih. The policy from Saudi Arabia is changing as the country streamlines its financial management and prepares to digress its sole dependency away from oil revenues. Al-Naimi has been the vociferous leader of OPEC for many years and now OPEC ministers will have to learn and understand the new agenda from Saudi. Will Saudi continue to support OPEC interests or its own and that is what they want to know.

Countries like Venezuela and Algeria would have come along, no doubt looking for support but their long term former ally, Iran, wasn't interested in playing games and had no interest in any deal that curtailed its objective of producing 4mbpd once more. Russia which used to be an observer was not present and hasn't attended for at least three years.

In the opening stages, we were able to meet with ministers and glean from them an idea as to what they were hoping for. There was a general view that the strategy was working for them. I spoke to Jose Maria Botelho Vasconcelos the charismatic Minister for Angola. He is pleased that progress is being made but would like a little more, like $60 or even $80 but he was, as always very relaxed in his views. The Kuwait Minister confirmed that the recent strike of refinery workers in Kuwait was settled on the third day and will not be a long term issue while the Minister for UAE told me that the Doha Meeting did not materialise in agreement because not all OPEC members were present and all need to agree for anything to happen.

The opening address went through the various announcements regarding new ministers as some change frequently before coming to a level of analysis. They noted that the OPEC Basket Price fluctuated around December and January and having fallen to $22 has since risen to over $40 and yesterday it closed at $44.16 down from $45.15, against the background that an output deal was under discussion! OPEC is pleased with this progress but disappointed that spending on global exploration and production fell by 20% last year and that a further drop of 15% is expected this year. However, with the latest data showing a level of recovery perhaps the concern is a little premature.

OPEC has revised its figure for global economic growth down slightly to 3.1% and believes that oil demand will increase this year by 1.2mbpd while on the supply side they are expecting a reduction of 740,000 bpd which presumably relates primarily to the US shale market. Over the last eighteen months OPEC has increased output to 32.50 mbpd and believes this to be the level required from OPEC during the second half of the year with the market coming in to balance. OECD stock levels are a concern to OPEC and with an estimated surplus of 360mb, OPEC believes it important that this level is reduced. COP21 is also on their agenda as all members are part of it but I really cannot believe that they have any interest in supporting it. The address ended with the acknowledgement that OPEC will continue to maintain its dialogue with non-OPEC producers, which so far has led to nothing.

Following on from the opening ceremony there is a delay of around five hours for delegates to meet and discuss. A well informed source advised me that there would be an agreement on output but I did not amend my draft report, thankfully. OPEC has decided that the market is performing well and that there is no need to take any action other than to monitor the market and encourage all producers to work together, to ensure that the market is well balanced. A new Secretary General, Mohammed Barkindo of Nigeria has been appointed for three years and I know him well so am looking forward to a closer working relationship with OPEC.

Looking back to when this new OPEC strategy first developed, in November 2014 when OPEC announced that it was going to keep on pumping oil to maintain market share and let the market stabilise itself, the price dropped $5 almost instantly. We had expected the usual supply cut but, looking back, why on earth would they keep on cutting output only to pass their market share over to a competitor. Again in June last year, perhaps some of us weren't too sure what they would do, but, once again, the policy remained unchanged and the price fell further.

That June Meeting was very much overshadowed by the OPEC Seminar which had much of the World's top oil industry personnel present and contributing, giving them all a first hand view of the OPEC strategy. Then again at the last meeting, in December, it was as if the Meeting had never happened and they simply announced that they would continue to monitor the market and meet again in June, today. During the day there had been some very strong rumours that a cut was in the offing but again in reality, what would that have done? The price was hovering over $40, Shale rigs were still operating and it would simply have given them more respite too. Yet the underlying argument was that non-OPEC had to join in too, as well as all OPEC Members and in the background the vendetta between Saudi and Iran rumbled on.

So, once again we have listened to the rumours of caps, cuts and freezes and OPEC has again declared that its policy is working and will remain on course for now. To highlight the changes that have taken place since November 2014, key indicators are illustrated below.

The obvious figure to follow is the total US Rig Count which has fallen from just under 2,000 in November 2014, when OPEC announced the new strategy, to 404 last week. Output is now falling and by the end of this year could be down by 600 to 800,000 barrels per day. Many Banks and Operators are facing financial run. When finance was originally raised and given, the price of oil was well over a $100 with a fall-back figure of around $80, but with many going in to administration as it fell towards $30 the industry has some way to go before it can recover.

Nevertheless, those that have survived and those that are coming in to the market will do so at a lower level and will not base their analysis on $100+ with a contingency level around $80. They will have to work on the $50+ range. Assets will be disposed of and acquired cheaply while the shale oil and gas resources will wait for the next round. This could come soon if the price rises above $50 this year or next and that is the dilemma for OPEC. At what point does OPEC expected Shale to come back? It can't ignore it because it will return. During the Press Conference I asked the President if OPEC would be following the US Shale market and had a view on when it would return having lost nearly eighty per cent of its oil and gas rigs since December 2014. I did not get an answer!

World stock levels are high, giving a cushion should there be a shortfall and these will start to fall back but the other interesting number is that, over the same period, OPEC output appears to have increased by around 2.5mbpd.

Now with talk of any kind of output control, which OPEC members will actually want to cut, having increased to maximum levels anyway. The only solution put forward so far has been the capping at maximum levels which will have no physical impact in the foreseeable future.

The adjoining chart illustrates the crude price levels over ten years during which the market has peaked and troughed to the point that one cannot realistically depend upon a sustainable price level.

The WTI price usually tracks the Brent price but there are periods when pipelines are down and the product is landlocked and cannot be readily moved in great volume but for now it is back in alignment and the three – Brent, WTI and OPEC follow each other closely.

From data given out by the IEA and the EIA and others, it would seem that supply and demand are coming together again and that later this year could be back in balance. Thereafter, it seems more conclusive as shown in the adjoining table from the IEA while a similar view is given from the EIA in the next table below.

This is exactly what the strategy is about, certainly in terms of managing the OPEC output and meeting competition head-on and other producers must now be prepared to accept this and recognise the days of easy money are gone for now and may not return for some time.

Of course, this is purely the Saudi view, supported by GCC State Members, Kuwait, Qatar and UAE and collectively, they make up 50% of the OPEC output.

So Saudi is not strictly speaker alone in its strategy. Similarly, they will share views on Iran and this adds another dimension to the strategy.

As I have said before, Saudi and Iran are on opposite sides in both Syria and Yemen where they are indirectly fighting each other.

Furthermore, Iran needs to move its tankers through Saudi waters and Saudi is making it difficult for Iranian vessels to pass through.

OPEC is perhaps the common meeting ground where they have to meet around the same arena and wherever possible leave other issues out of the room.

The Exchange Rate is another issue that impacts on OPEC as oil is traded in dollars and so fluctuations will work for and against them. As a guideline for our UK Clients the adjoining chart illustrates the volatility in the Sterling-Dollar rate.

For consumers a stronger dollar we pay higher prices and this is why Petrol and Diesel prices often change without a corresponding price change for oil. While for sellers will benefit from a weaker dollar depending up the rate with their own currency.

Hedge Funds and others need to be in tune with both currency exchange rates and oil prices to effective succeed at trading.

The IMF has recently published it World Economic Outlook and this too also illustrates a positive trend for OPEC and of course the oil industry. Global GDP is set to increase as is oil demand later this year. The figure for Global Industrial Production was not available as this report was being compiled but the data certainly does give some support to a stronger market.

One somewhat negative aspect is that Chinese data has not been as strong as had been expected and China is a key user of energy and oil in particular. Exports have not moved sufficiently ahead and that is where China has succeeded for many years. The Purchasing Managers' Index (PMI) which remained unchanged from April to May at 50.1 but alarmingly the Caixin/Markit Manufacturing PMI showed a decline from April to May from 49.4 to 49.2 when it had been forecast to fall to only 49.3. China is a market leader dependent upon exports across the World, particularly to the West, and with its economy struggling, this is as much of an indication that the rest of the world, by not buying from China, is perhaps not moving ahead as fast as it should.

Over the last six months as some OPEC members have struggled to cope with the lower oil price, some have sought finance elsewhere as even Saudi has, while Venezuela, being funded on the one hand by deals with China, has been selling off its gold reserves. Even if the price of oil returned to $100+ it still wouldn't be able to cope. Internal strife is building up and there seems to be a strong consensus that Maduro the current President will soon be forced out. The low oil price will be blamed but the issue is deeper than that. Venezuela with Russia has been keen to promote the idea of some kind of Non-OPEC - OPEC deal but the plan did not materialise and certainly could never work unless Iran signed up to it too. A cap or freeze at maximum output levels is not something that would be tangible and whatever it was, it may have been symbolic but it would not have had a serious impact on the market.

Looking ahead, the market will hover around the $50 level for a while, worried about supply disruptions which are purely temporary. The most serious being from Canada at around 1mbpd while a similar figure is probably being lost in Nigeria from civil strife in the Delta region. This is an ongoing problem with massive poverty and unemployment in and oil rich region. It is also a regular occurrence and one that can be dealt with and usually is. Civil war in Libya is holding upabout another 1mbpd and there have been talks to agree peace between the two sides but with an estimated force of IS fighters now in the country, numbering several thousands, the aspect of peace seems more distant. However, oil will flow again at some point. Meanwhile, Iran is pushing ahead to increase its output and to bring in external expertise while Iraq too is increasing output where it can. Overall in May, OPEC was estimated to have produced over32.50mbpd, some way above the original ceiling level of 30mbpd.

The oil price is generally unpredictable and the fact that it recently rose to $50 and fell back again, reflected premature excitement from traders that there might be some kind of deal to control output. As many of them had been holding back, for fear of prices falling, as the mood became more positive, many were back in the market buying in anticipation that price would rise.

Now, that there is a realisation that OPEC will not be restricting output, traders are caught long with too much oil in a falling market and so once $50 had been reached, there was a general mood to sell off rapidly and this was also happening as news circulated yesterday that there may have been a deal today. So, $50-55 is possible at times during the remainder of the year but less is also possible and the adjoining table indicates where various forecasters see prices flowing during the next eighteen months or so.

In conclusion OPEC must realise that as supply and demand come in to balance there will be more upward pressure but at the same time, we may see alternative energy sources trickling back in to the market. Is there a plan? If there is, we shall have to wait for it. There was also much talk of the “supply crunch” if output is not co-ordinated plus “is OPEC dead?” I don't believe that OPEC needs to take any “co-ordination” action and that geo-political tension is a far more dangerous aspect to the “supply crunch”.

In this arena, surrounded by so many like-minded people from different parts of the world and with different cultures, one is very much aware of the lack of appreciation for cultural differences which is very much the driver of the extreme geo-political tension that currently exists across much of the world. For the final word – OPEC is not dead, it is very much alive and still producing 40% of the world's oil needs.

I hope I have given a balanced view in this report, much of it written in great haste. Some will agree and others may not but if there are any points that you would like to discuss with me, please let me know. The next OPEC Meeting has been scheduled for 30th. November 2016. I shall be following events in the meantime and shall be there.

John Hall is a London-based analyst and Petroleumworld contributor who runs his own oil consultancy, John Hall Associates . Further information please contact: John Hall, John.Hall@Alfaenergy.co.uk +44 7880 367773 or + 44 7785 274530. Petroleumworld does not necessarily share these views.

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