Yesterday saw OPEC agree plans to cut oil production for the first time in eight years, in an attempt to stabilise the market and push crude oil prices higher. The announcement, made by OPEC president Mohammed Bin Saleh Al-Sada in Vienna yesterday afternoon, led to a short-covering[1] fiesta in the oil sector as the price of a barrel of oil rose, boosting the share prices of oil majors.

The headline agreement

  • OPEC announced a production cut of 1.2 million barrels a day (mmbbl/d), to bring its production ceiling to 32.5 mmbbl/d. This is at the lower end of the cuts that had been proposed at the Algiers meeting in September this year.
  • Saudi Arabia agreed to cut 486 thousand barrels a day (kbbl/d), with Iraq, UAE, and Kuwait to cut 480 kbbl/d combined. Libya and Nigeria are exempt. Meanwhile, Indonesia is terminating its membership and is therefore excluded (note: the headline reference cut does not include the reduction in output following Indonesia’s departure), and Iran has been given the go-ahead to increase production by 90 kbbl/d.
  • The deal is ‘contingent’ on a corresponding non-OPEC cut of 600 kbbl/d, half of which is expected to come from Russia, with the source of the remaining cuts undisclosed. OPEC has received positive assurances from Russia of its commitment to this cut. However, the OPEC president did not confirm it was a binding agreement during the Q&A which followed the announcement. A meeting of OPEC and non-OPEC countries is scheduled for 9 December 2016 – we expect more details on non-OPEC measures to follow thereafter.
  • Cuts will be implemented from 1 January 2017 for approximately six months, and reviewed at the next OPEC meeting on 25 May 2017, with the intention being to extend for another six months.

How does this affect our outlook for the oil sector?

Our view, continuing on from the Algiers meeting in September, is that while adherence to the agreement is far from certain, the deal again highlights the limited downside for oil prices.

However, the path for how prices might move sustainably beyond $60 per barrel is still open to debate. Inflection points in inventories have tended to drive prices more than absolute inventory levels, and oil equities have certainly been leveraged plays on that. 

Technical analysis shows us that oil is at a critical juncture, which suggests a fine balance between risk and reward as arguably attractive cash-flow valuations vie with macroeconomic concerns and US-dollar strength, against a backdrop of recent sector rotation.

 

 

[1] Short covering refers to the practice of purchasing securities to cover an open short position. Traders may sell a stock short because they believe the stock price will fall. But if the stock’s price goes up, the trader may choose to reduce or eliminate exposure to the short position.

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