Declaration of intent triggers oil price rally
This Sunday, major oil producers will meet in Doha, Qatar. They will discuss a possible agreement between both OPEC and non-OPEC producers to freeze production at January levels. This meeting follows an earlier agreement in February to freeze production between Saudi-Arabia, Qatar, Venezuela and Russia. We see the existing agreement as a clear signal towards the market that the oil producers involved, found that the oil price of USD 30/bbl – the actual spot price at that time – was too low. If production growth is frozen, supply and demand will become more balanced in time. As a result of the agreement – or declaration of intent – oil prices rallied based on expectations, or hope, that the oversupply will diminish in the course of the coming time.
Expectations for the upcoming meeting in Doha are high. This triggers speculation and increased expectations for a further cut back of oil production growth. We expect that there will be more countries which will join the existing agreement. An actual cut in oil production seems very unlikely to us. After all, the current ‘verbal intervention’ has already had a supportive effect on oil prices as they have moved up from the dramatic low of USD 30/bbl.
Both Iran and US will not join an agreement
Iran indicated that it will attend the Doha meeting, but it will refrain from actually participating in the production freeze. Looking from Iran’s perspective, this is understandable. Now sanctions have been lifted, Iran is willing to regain its lost market share, and even – in line with Saudi-Arabia’s production growth – to increase the pre-sanction production level with another ten percent. We believe that this aspect is already priced in by market participants, and should not be a burden for an agreement between other oil producing countries. For practical reasons, it seems unlikely that US oil producers will join the production freeze agreement. Nevertheless, we don’t expect a rapid rise of US oil production even if oil prices continue to appreciate. Simply, because those producers will be cautious to restart projects as a result of budget restrictions. On top of this, limited storage capacity will make it more difficult to sell the extra volumes of oil produced.
Oil prices set to appreciate further
In recent days, oil prices rallied to the highest level in 2016. There is a significant risk that the market will be disappointed by the outcome of the Doha meeting. Even if there will be an agreement which indicates that more oil producers will join the existing production freeze to January levels, profit taking on recent oil price gains seem likely. The actual positive effects of a production freeze – in other words a better balance between supply and demand – will likely take place in the coming months. This is consistent with our current oil price forecast. We expect oil prices to continue to appreciate in the second half of the year, while volatility will remain high. The market focus will therefore continue to switch between oversupply and record inventories on one hand, and a better market balance – as a result of a rise in oil demand and stable oil supply – on the other hand.