After failed Doha talks, Kuwait strike may lift oil price

OPEC and several non-OPEC producers failed to reach an agreement to freeze production in Doha today, Sunday April 17. Participants commented on requiring more time to reach a deal although the key stumbling block appears to be the requirement by Saudi Arabia that Iran participates. Saudi’s stance is consistent with comments by deputy crown prince Mohammed bin Salman during two      interviews with Bloomberg this month (April 1 and Thursday April 13) and goes against Iran’s long held goal to quickly increase production to recover market share. On its own, we view this outcome as bearish for oil prices given consensus expectations for a “soft guidance” freeze at January production levels. But this lack of an agreement does not imply that OPEC production will recover in the short-term, as the year-to-date stabilization owes to ongoing disruptions and maintenance rather than coordination. It is further of no impact to our forecasts as year-to-date production of OPEC (ex. Iran) and Russia have remained close to our 2016 average annual forecast of 40.5 mb/d.

Further, the weekend also saw the start of Kuwait’s oil worker strike, which according to Bloomberg has led to crude production falling to as low as 1.1 mb/d from 2.85 mb/d in March, which is significant and can lend further support to the recent strength in Brent and Dubai timespreads. The level of the actual disruption remains uncertain as the latest comments of the oil sector spokesman were of unaffected oil exports and of production rates gradually improving with normal levels “not far off” (Reuters as of 3 pm EST). In addition, the Kuwait Oil Co. is aiming to find laborers to support production. But while this strike may be short lived (it is a labor dispute and not a disruption), ongoing OPEC production disruption, gradually declining non-OPEC production as well as planned maintenance in the face of resilient oil demand in 1Q have recently pointed to improving oil fundamentals. This leaves the market reaction early this week as uncertain, with risks skewed to a sharp sell-off only should the Kuwait disruption prove much smaller than suggested so far. Either way, we believe that the weekend headlines will further support the already high level of price volatility.

Beyond these weekend headlines, our outlook for oil prices remains that gradually improving fundamentals, driven by non-OPEC production declines and not OPEC or Russian production, will bring the market into a sustainable deficit in 3Q16, which will maintain a deeper backwardation across both Brent and WTI forward markets. Low prices earlier this year lead non-OPEC producers to guide to lower production, with recent data confirming these declines in the US as well as in other high cost producers such as China, Latin America and the FSU. Preliminary 1Q16 demand also surprised to the upside in India and Russia. And while the market remained in surplus in 1Q16, March high frequency stock data show a modest product led 2.5 mb draw relative to seasonal.

The risk to higher oil prices in coming weeks is that this recent improvement in fundamentals was helped by disruptions and maintenance, which have reduced global supplies by 500 kb/d in March-June (ex. Kuwait), with the demand surge seasonally driven, all suggesting that once this passes, the rebalancing process and inflection phase will continue for several more months.

n fact, beyond the end of disruptions and maintenance, there remains potential for higher production than we forecast from several OPEC members. Iran, the Neutral Zone and Libya could potentially provide additional production growth in coming months, with vessel tracking over the past two weeks pointing to rising Southern Iraq and Iran exports.

Finally, while we expect Saudi production to only rise to 10.35 mb/d during 2Q-3Q16, this simply reflects a smaller than seasonal increase in Saudi crude burn for power generation, given (1) normal weather vs. last year’s average hot temperatures, (2) the ramp-up of the Wasit gas processing plant, (3) reduced fuel subsidy and government expenditures and (4) potentially reduced military demand should the Yemen truce, started April 10, prove sustainable. We therefore view risks to our Saudi forecast as skewed to the upside: it is at the guidance provided by the deputy crown prince in his latest interview with Bloomberg this week, with such volumes presented as contingent on a deal to freeze production being reached.