Is Saudi Arabia Signaling A Return To Being A Swing Producer, At Least For 2017?

Dec 12, 2016


Spot oil price has jumped up this morning.  As of 6:45am mountain time, WTI has pulled off its highs, but is still trading up sharply by $2.20 to $53.70 on the weekend news that (a) Non-OPEC will reduce 0.558 million b/d for 6 months, and (b) perhaps more importantly, Saudi Arabia says will be cutting “significantly” more than the Nov 30 OPEC deal commitment of 486,000 b/d.

It is a bigger price increase than we expected and a jump up like this always reminds me of analyst lessons that I first learned in the late 90’s.  First, the market tells you what capital believes and not what an analyst expected.  Second, speculators/traders live in the liquidity and volatility of the spot oil price.  Third, it reminds to see if you are missing a bigger picture interpretation of the events/facts/data ie. don’t miss the forest for the trees.  The reality is there were a lot more lessons, but they all come back to priority of an analyst – be objective, be analytical, be practical, be diligent, be hard working, and be honest in looking at events to help your clients.

The non-OPEC cut wasn’t expected by most.  Clearly, the ability of Non-OPEC to reach a deal was not priced in to spot oil price.  WTI spot had drifted down to close at $49.90 on Dec 7 on the tone moving to no non-OPEC deal being reached in Vienna on Saturday, but by Friday Dec 9 close, had moved back up to $51.46 with the tone moving more to a non-OPEC deal being reached.   One of the reasons we wrote a Wed Dec 7 evening blog “Non-OPEC 14 Should Reach A 0.6 mb/d “Reduction”, But It Isn’t Likely To Move Oil Prices[LINK] was that we believed non-OPEC would reach a deal on the weekend. However, the big increase in spot oil this morning is telling us a deal wasn’t fully priced in.

The non-OPEC deal particulars aren’t as significant as getting a deal.  Its clear that getting a deal done was more important than the details of the deal.  The non-OPEC deal this weekend was less than expected in the OPEC Nov 30 announcement.   The OPEC Nov 30 deal was to see a reduction of 600,000 b/d from non-OPEC.  This weekend’s deal [LINK] sees Non-OPEC agreeing to a 558,000 b/d reduction. There was no formal by country allocation in the OPEC announcement.  But TASS reported [LINK] that Russia’s 300,000 b/d cut gets phased in with the first 200,000 b/d likely not until March and the last 100,000 b/d after March.  Plus Mexico’s 100,000 b/d reduction is less than its own forecast decline [LINK] in 2017 of 186,000 b/d ie. oil supply forecasts already assume a bigger Mexico decline that its 100,000 b/d Vienna commitment .

Saudi’s comment that it will cut “significantly” more than its commitment is the other factor leading to the jump up in oil price.   The other big news this weekend was the Bloomberg new story [LNK] that noted “Riyadh agreed with OPEC on Nov. 30 to cut its production to 10.06 million barrels a day, down from a record high of nearly 10.7 million barrels in July.  “I can tell you with absolute certainty that effective Jan. 1 we’re going to cut and cut substantially to be below the level that we have committed to on Nov. 30,” Saudi oil minister Khalid al-Falih said after today’s meeting.  The Saudi minister said he was ready to cut below the psychologically significant level of 10 millions barrels a day — a level it has sustained since March 2015 — depending on market conditions.”

Saudi going below 10 million b/d isn’t a significant change to Q1/17 oil supply.  The math of al-Falih’s comments don’t really change the oil supply picture for Q1/17.  The Nov 30 OPEC deal sees Saudi Arabia committed to reduce on Jan 1, 2017 by 486,000 b/d to 10.058 million b/d. An additional 100,000 b/d cut could be interpreted as being “substantially” more than the 486,000 b/d cut, and would take Saudi Arabia to 9.958 million b/d. We don’t see a 100,000 b/d cut really changing the Q1/17 supply picture as the non-OPEC deal is 42,000 b/d less than expected, and the first 200,000 b/d Russia cut isn’t likely until March.  However, an added 200,00 to 400,000 b/d added cut would be significant.

Especially as OPEC reportedly produced 200,000 b/d more in Nov than Oct.  The other reason why an additional 100,000 b/d  cut wouldn’t significantly change the Q1/17 supply picture is that OPEC’s oil production is higher in Nov than Oct.  The OPEC Nov 30 deal was based on Oct oil production.  Last week, Bloomberg estimated that OPEC’s Nov oil production was up 200,000 b/d in Nov to 34.160 million b/d, vs 33.960 million b/d in Oct. The negative in the estimates Bloomberg estimating Libya was up 60,000 b/d to 0.58 million b/d, and Nigeria was up 80,000 b/d to 1.68 million b/d. Libya and Nigeria were excluded from any reductions and their increases add to the challenge for OPEC to get to their 32.5 million b/d level.

The bigger question is Saudi signaling a return to being a swing producer, at least for 2017?  This ties to point 3 of our lessons, are we missing the forest for the trees.  As noted above, an additional 100,000 b/d cut to go below 10 million b/d doesn’t have a big impact on the Q1/17 oil supply picture.  But is Saudi telling us that they are prepared to return to being the swing producer for 2017 when they alone are prepared to act without requiring others to act?    The Bloomberg story makes no mention that Saudi needs others to share the burden of additional cost, rather they indicating they are prepared to do all it needs to do to drive oil prices higher without requiring Iran or Iraq or others to share the additional burden.  At least for 2017!

It makes sense for Saudi Arabia to be the swing producer in 2017.  We don’t see the swing producer role being as influential or powerful over the other OPEC producers.  In the old days, Saudi Arabia had a hugely dominant financial position over the OPEC producers.  So it could effectively dictate that the others follow the Saudi lead.   We don’t believe that is the case anymore, especially in dealing with Iran.  However, there is the logic that Saudi Arabia plays a swing producer role in 2017, partly because they need solid oil prices ahead of the planned early 2018 Saudi Aramco IPO and partly because Iran is only getting stronger. Saudi doing more than they promised may not attract OPEC followers, but it can encourage the others comply.  Our Nov 14, 2016 blog “Countdown To OPEC’s Nov 30 Meeting – Part 3: Part 3: Better To Deal With Iran Now Before They Get Even Stronger[LINK] concluded “There is no question that a Nov 30 quota agreement will be tough to get done and that a deal will fall mostly on the shoulders of Saudi Arabia.  We believe Saudi Arabia has run out of time and needs oil prices to return to $50 and not $40.  Saudi Arabia’s financial position is getting worse and it publicly committed to an early 2018 Saudi Aramco IPO whose valuation will depend on 2017 and 2018 oil prices. Iran doesn’t really lose much by “agreeing” to a cap as the oil production growth post removal of sanctions is almost done. But perhaps most important of all, the removal of the sanctions has put Iran into a period of strong economic growth (when others are getting financially weaker) and this should only increase Iran’s negotiating leverage in future.  Even with the negatives, it may well be the best possible time for Saudi Arabia to grit their teeth and accommodate Iran.  Iran is expected to only get stronger economically”. 

Oil had less downside risk and a better chance to go $60 in 2017 if Saudi Arabia plays the swing producer role in 2017.  The non-OPEC deal was less than expected and OPEC’s starting point for oil production was higher 200,000 b/d higher in Nov.  However, oil is up strongly, telling us that a non-OPEC deal wasn’t fully priced into the spot price. The Saudi Arabia comments on added cuts to even go below 10 million b/d may not significantly change the oil supply picture in Q1/17.  But, if Saudi Arabia is prepared to play the role of swing producer in 2017, this will provide better support for a higher floor price and more confidence that oil can move to $60 in 2017.