What's Next For Oil After The New OPEC+ Deal

  • Jul 20, 2021
  • Zero Hedge

The recent OPEC+ meeting ended with an agreement that would gradually increase the cartel’s monthly production until in late 2022 all of the 9.7 mm BOPD that had originally been withheld from the market, was restored. There was already an agreement in place through December of 2021, but the Kingdom of Saudi Arabia’s, (KSA) desire to extend it to the end of next year was a bone of contention with the United Arab Emirates, (UAE). This agreement was not reached easily and required some negotiation and compromise to achieve. It has been widely reported that the crux of the disagreement between KSA and the UAE, was the latter’s desire for a higher output ceiling from which its share of curtailment would be calculated. This, while certainly true, is not the only factor in the new assertiveness demonstrated by the UAE in OPEC affairs.

There is a dichotomy of perspective about the peak for oil that has developed between the KSA and the UAE. The Saudis’ five year plan to diversify their revenues away from oil has not been as successful as initially hoped, and they now view oil production as underpinning their economy for decades to come. They also view the transition to renewables as having a multi-decade arc that will keep demand for oil and derivatives relatively high over this period. The new, higher price regime in or near the $70’s is a breath of fresh air for their economy.

The UAE have had more success in attracting foreign investment, and on a parallel track, have energized their oil sector with a $122 bn investment plan, to dramatically increase production in the near term. Their view on the energy transition is that it will have a much shorter arc that could lead to substantial reserves being “stranded.” A very undesirable outcome for this tiny middle-Eastern nation, and makes them want to up production regardless of the impact on prices. This the underlying fear behind their insistence on a higher baseline for allocating their share of OPEC+ production. This led to the impasse that resulted in the first meeting ending abruptly with no statement forthcoming, as per usual.

This divergence in viewpoint has caused the UAE to purposefully step out of the shadow of the Saudi’s in discusses revolving around output. As we will learn, there was considerably more involved between these two key OPEC members than just raising the output levels. In this article we will take a deeper look at the regional tug of war that has developed for shaping the cartel’s destiny. A tug of war that has global implications on oil availability and price. First we will take a quick look at these competing philosophies as regards peak oil.

The Saudi Vision 2030 plan was rolled out in 2016, with considerable fanfare when Mohammed bin Salman, (MBS) was named Crown Prince, becoming the defacto heir to the throne. The 2030 plan included a series of mega-projects including a futuristic city called Neom, that was intended to dramatically lessen the kingdom’s reliance on oil exports for revenue by 2030.

This year, the five-year point since its implementation, the 2030 plan has under-performed its billing with less than half the planned revenue forecast from non-oil sources being achieved. Masked in the details is the fact that much of the actual increase has come from new taxes and not new outside investment, as noted in the linked article.

Some of this may be associated with some missteps by the Crown Prince along the way. The Kashoggi killing, the privatization of Aramco failing to draw much external interest, a $200 bn solar farm that failed to draw enough support to get off the drawing board, and an attempt to launch a nuclear power project have all contributed to a sense of a lack of direction in the investment community.

With many internal problems associated with a young population that lacks preparation for modern employment, an economy that shrank 3% from the impact of the pandemic, and weaker growth internally from high taxes and subsidy cuts, KSA has struggled to balance its books. With external cash inflow insufficient to meet its economic needs the Kingdom has renewed its commitment to a heavier reliance on oil for longer into the future than it thought would be necessary just a few years ago. An energy consultant located in Dubai was quoted in the linked article as saying-

“In the past five years, Saudi Arabia has made little progress in alleviating its reliance on oil-export revenues. It is probably going to take over 30 years to move away from oil dependency.”

The UAE’s plan doesn’t have an iconic name as does KSA’s, but the country has met with more success on a number fronts on a relative basis. Its privatization of certain aspects of ADNOC properties, selling stakes in ADNOC subsidiaries drew $25 bn of foreign capital into the country without the trauma of actually going through an IPO process for the holding company. Something that was painful for the Kingdom. The UAE is now producing power from a 400+ MW plant in Dubai, and even in the nuclear power area the Emirates have outstripped their larger neighbor with a nuclear generating plant that’s come online just this year.

The UAE has even gone a step further and successfully introduced a new futures contract on their production, known as the Murban. This is meant to facilitate their trading and optimize pricing and volumes within the production limits set by OPEC.

The Emirates are also looking to move higher in the petroleum value chain with a $45 bn expansion of the Ruwais industrial complex. In this effort the country’s refining capacity will be doubled and a huge petrochemical complex will be built. Euro major oil companies, BP, (NYSE:BP), TotalEnergies, NYSE: TTE), and ENI, NYSE:E) are partners in this enterprise, and hold Production Sharing Agreements-PSA’s, for upstream development in the country.

The major piece of this initiative was not launched until November of last year when it was announced that the country would begin a $122 bn expansion of ADNOC’s oil output with a goal of raising production to 5 mm BOPD. Which brings us back to the current state of affairs and competing philosophies regarding how best to extract the maximum value from their petroleum reserves. But, first let’s look at some of the regional power struggles that contribute to the tension between the two countries.

The Middle East seems an eternal hotbed of conflict of one type or another. Many factors play into this and we will focus on the competition for ascendancy in the region between KSA and the UAE.

The Saudi/Iran proxy war in Yemen has been in and out of the news in recent years, but it drags on year after year. A key supporter of KSA in the effort to subdue the Houthi rebels has been the UAE. In 2019 it announced it would withdraw its troops from the conflict. A blow to Saudis attempt to call the war effort a regional coalition.

The easing of tensions between the UAE and Israel in a U.S. brokered peace deal have deepened the mistrust between these two states as well. Saudi remains deeply divided about Israel because of the Palestinian question, and looks to regional neighbors for support for their cause.

Then in another regional power shift, KSA buried the hatchet with Qatar leaving the UAE out in the cold, and forced go along. The two countries for years had engaged a blockade of Qatar, until a U.S. brokered peace agreement led to a truce early this year in the last administration.

With the regional back and forth taking place on other fronts, it was clear that the UAE had to at least “rattle the cage” of OPEC+ to protect its interests.

From the announcement that came out of Sunday’s meeting, it appears that the UAE got most of what they were seeking in terms of increasing their production baseline. Other countries including Saudi Arabia, Russia, Kuwait, and Iraq also saw their baseline quotas raised, so this was a shared victory.

With the production management agreement extended through December of 2022, Saudi also got a key win for their concerns about too much oil driving prices down. On the horizon also is the potential return of about 1.5 mm BOPD from Iran once sanctions are lifted. The statement included language about the cartel reviewing this policy in the event this crude lands in the market.

Prices for many grades of crude fell on the announcement of 400K barrels being returned to the market, with August contract for WTI dipping below $70 in Monday’s futures for the first time since early June. As I noted in an earlier OilPrice article when this outcome for OPEC+ was on the horizon, the global market can easily absorb this crude, assuming the recovery from Covid-19 continues. I think it will. The EIA projects that U.S. YE 2022 production will be ~12.2 mm BOPD. This breaks down to 1.8 mm BOPD from the GoM, and ~400K BOPD from Alaska, thus requiring shale production at ~10 mm BOPD. A boost of 2.2 mm BOPD from today’s rate of ~7.8 mm BOPD, and taking it far beyond the highest level ever produced in the shale patch.

I think expecting this variable to perform at the EIA’s assumed level is unrealistic. This agency has some rather simplistic assumptions used in making these estimates that mainly are backward looking and assigning rig numbers with crude production. This doesn’t take into account the fact that DUC-Drilled but UnCompleted wells withdrawal have been largely responsible for controlling the rate of decline this year in the face of reduced activity from prior years.

In March of 2020, shale production peaked at 9.3 mm BOPD on the strength of a peak 1,100 Rigs in the prior 15 months, and 420 active frac spreads.

As we know the service and supply industry has been turned on its head the last three years, and is much smaller in terms of deployable rigs and pumps. Personnel have also been eliminated at a rate never before seen in an industry known for wide swings in activity. In our view these reductions along with the stated intent by the industry to repair balance sheets and reward investors with stock buybacks and improved dividend payouts, augurs against a return to 2019 in terms of activity.

The next variable is the rapid spread of the “Delta” Covid variant. This, in my view, is more a matter of perception than a sea change in the general direction of the recovery. While more transmissible than the original strain, it seems to result in a milder infection, and the vaccines are near 97% effective in preventing infection. And, of course the good news that seldom gets reported is the infection itself in the unvaccinated will eventually bring about the “herd” immunity among the population that will render Covid to essentially the same status as the flu. Some you live with and doesn’t cause a wide spread panic.

The upshot of all of these factors-the OPEC+ agreement, production rates and North American shale activity levels, is that despite fluctuations due to market driven changes in sentiment, the price trend for oil will be higher.

These changes in sentiment will be transitory in my view, creating opportunities to add to positions in key companies likely to benefit from these higher prices. Companies like Halliburton, (NYSE: HAL), Schlumberger, NYSE:SLB), Devon Energy, (NYSE: DVN), Occidental, (NYSE: OXY), ConocoPhillips, (NYSE:COP), Pioneer Exploration, (NYSE:PXD) are poised to report a resoundingly improved QoQ performance from Q-1, that will drive their stock prices higher.

Investors who believe that the economic recovery that began last year with the announcement of the effectiveness of the vaccines, will continue should view the current ~20% average sell-off in the last couple of weeks as a buying opportunity.