Ahead of the eagerly anticipated Organization of the Petroleum Exporting Countries meeting in Vienna on Wednesday, many investors have adopted a cheerier outlook on oil price expectations.
Though delegates from the 14-member group appeared to have ended Monday’s discussion on a good note, Tuesday’s negotiations were considerably more turbulent, with a stand-off between petroleum heavy hitters, Saudi Arabia and Iran. In turn, the price of Brent crude oil toppled and was down 3.6% to $46.49 per barrel at the time of writing.
While Leung believes that the group’s desire for self-preservation will ensure an agreement is reached, he thinks markets and investors are being unrealistic about the likelihood of an oil price rally.
“Arguably the biggest stumbling block to higher oil prices longer term lies with the willingness of Iran and Iraq to adhere to any supply cut agreements,” he said. “Iran, looking to reclaim lost market share following years of trade embargoes and isolation, and Iraq, heavily reliant on oil revenues to fund its fight against ISIS, maintain strong incentives to defer from production cuts.”
But the prospect of offering concessions to Iran and Iraq leads to a damned if you do, damned if you don’t scenario for Saudi Arabia, the cartel’s largest producer, which would have to shoulder the burden of Iran’s and Iraq’s extra production cuts, said Leung. “Unless concessions are offered, Iran and Iraq will continue to avoid committing to any deals, undermining negotiation efforts and signaling a return to the status quo of high output, low prices and continued fiscal pain.”
“At the same time, any concessions offered will not only blunt the effectiveness of a supply cut, since the two are the second and third largest oil producers within the bloc, but also set a dangerous precedent that could encourage other OPEC members to cheat. Therefore, the immediate success of any agreement hinges upon an amicable solution emerging.”
And if an ‘amicable’ output agreement is reached by OPEC’s members, the threat of US shale oil still exists, Leung stressed.
“Any supply void left by OPEC will likely encourage nimbler US shale oil producers to start pumping again; their efficient production techniques enabling them to produce at much lower costs,” he explained. “US oil rigs take approximately four months to adjust to higher (or lower) oil prices. This implies that any supply cut will only provide a temporary boost to prices, before attracting other producers to commence operations again and limiting OPEC’s advantage from higher prices.”
President-elect Donald Trump’s move toward US energy independence could also put a damper on OPEC’s attempts to bolster flagging oil prices. While Trump’s energy policy remains ill-defined, like most of his other proposals to date, it is not unreasonable to assume it will involve opening federal land for oil and gas production, Leung stated. Years of this ramped up domestic production would strain oil prices further.
Although the Vienna meeting has the potential to “correct the persistent supply gut,” ultimately supply side dynamics will continue to dictate the strength of pricing pressures, according to Leung. “The balance in oil markets remains delicate with global demand still lackluster and not expected to accelerate in the near future,” he said.