OPEC and key partners opted for a middle path coming out of the 175th
meeting of the OPEC Conference, agreeing to cut oil production by 1.2
million barrels per day (bbl/d) from October levels (an even steeper cut
than versus November levels). We expect the move to support prices in the
low $60s/bbl for Brent crude and in the mid-$50s for WTI.
We believe the production cuts are prudent and represent a “third way” to
address market concerns that seeks to avoid some of the negative outcomes
of recent moves. In 2014, OPEC elected to pursue a policy of market share
rather than output cuts, which led to a collapse in oil prices; in 2016, in
coordination with several non-OPEC producers, the cartel reversed course
and cut output, spurring a gradual doubling of prices. This year’s OPEC
agreement seeks to limit the market imbalance and stem the recent price
decline while not driving prices substantially higher – a move that more
closely resembles behavior prior to 2014.
How we got here: evolution of the oil market in 2018
Oil prices had been on a steady upward trajectory after the U.S. exited the
Iran nuclear deal (Joint Comprehensive Plan of Action, or JCPOA) in May, aided by the previous period of OPEC output restraint. In June,
partly in response to the U.S. renewal of sanctions on Iran and to offset
declines in other producers, such as Venezuela, OPEC reversed course and
began opening the spigots. This helped push output to new record highs in
October and November.
October blog post, we cautioned that oil had run ahead of fundamentals and that a release of
waivers for Iran oil consumers could cause prices to retrace back to the
mid-$70s – effectively erasing some of the geopolitical risk premium that
had entered the market. Fast-forward two months, and oil had fallen
precipitously, well below the 70s, and the granting of waivers was
insufficient to explain the drop. A surge in U.S. supply, which has grown
by nearly 3 million b/d annualized over the past three months, was the
primary cause. In August and September, U.S. output was between
400,000–500,000 bbl/d above International Energy Agency (IEA) and consensus
projections. The surge was particularly notable given concerns about
pipeline constraints. In effect, both the U.S. and core OPEC producers each
managed to replace any decline in Iranian exports, allowing inventories to
This output jump coincided with a deceleration in global demand growth
owing both to temporary factors (such as low water levels in the Rhine
River that disrupted transport, leading to internal stock draws) and macro
issues, including a continued decline in global manufacturing purchasing
managers’ indexes (PMIs). Falling petrochemical demand, which coincided
with the drop in global automobile manufacturing, had a particularly
meaningful impact on the light ends of the barrel (i.e., liquefied
petroleum gases, such as propane and butane).
OPEC’s ‘third way’ sidesteps key risks
Against this backdrop, OPEC faced a particularly thorny challenge: Cutting
too much and supporting prices at too high a level would risk curbing
demand and supporting U.S. production expansion; and reverting to a market
share war would risk another price collapse, with the attendant collateral
damage to producing economies.
OPEC opted for a third way: Cutting enough to prevent notable storage
builds, while at the same time supporting prices at levels that should slow
U.S.-driven investment. The cut was below what the Joint OPEC-Non-OPEC Ministerial Monitoring
Committee (JMMC) had suggested was necessary to rebalance the market,
potentially leaving oil bulls disappointed. However, with prices below
$45/bbl in many onshore U.S. producing basins, a deceleration in U.S.
production growth should help achieve this ultimate goal. In addition,
lower prices should give demand a shot in the arm. Given the lower prices
and rebuilding inventories, we would also expect the U.S. to be aggressive
in pressuring Iranian exports heading into the second quarter of 2019, when
the current waivers are set to expire.
On net, we believe OPEC’s policy coming out of the December meeting should
support oil prices in the low $60s for Brent crude and the mid-$50s for
WTI. Downside risks could stem from greater-than-expected economic
deceleration. On the upside, a reignition of the global manufacturing chain
would go a long way toward supporting demand and market sentiment.
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