Doha non-deal not expected to affect timing of market rebalancing

April 2016 | Anders Norlen and Evelina Pagkalou


The Doha meeting between OPEC and non-OPEC producers ended in an impasse due to a standoff regarding Iran's production. The final agreement landed on a “wait and see,” with the next round of discussions scheduled for June.

Given the recent market volatility and the sensitivity of short-term prices to market sentiment, the lack of agreement has already fueled immediate downward pressure on oil prices. The feared price collapse has not been realized thanks to disruptions in Kuwaiti production, but oil prices will continue to suffer. Nevertheless, the non-deal is not expected to affect the timing of market rebalancing, as most producers who participated are already at record-high levels of production.

Background

The meeting was initially called for as a response to increasing production and to aggressive tactics to maintain and grow respective market shares among the leading OPEC members and Russia. Record outputs have been recorded by Kuwait, UAE, Saudi Arabia, Russia, and Iraq since the price collapse, with Iranian exports reportedly hitting 2 mbd in April, up from 1.5 mbd in March. Iran is currently ramping up output following removal of P5+1 sanctions in January. Saudi Arabia, the leading producer in OPEC, reported all-time high levels of production at 10.2 mbd at the beginning of 2016. Russia is in a similar position, reporting its highest post-FSU crude output in January and February at 10.9 mbd. Russia and OPEC have collectively increased their overall share of the market from 53.1% in 2014 to 54.4% in 2016, majorly contributing to the supply glut.

Despite previous deliberations, the deal ultimately failed when Saudi Arabia made its success contingent on Iran agreeing to a production freeze. Iran ended up not participating in the meeting, responding that it was not open to a production freeze at this point in time.

Exhibit 1


Short-term market impact

Oil markets have seen a sharp shift in momentum from mid-February up to mid-April. WTI and Brent prices increased by 45%, partly driven by expectations of a potential agreement at the Doha meeting. Changing views on the short-term production dynamics and high volatility pushed a record 150,000 short contracts on NYMEX to liquidation and prices sharply rebounded upwards.

The lack of short positions skewed price risk to the downside, creating price sensitivity to any news that would signal a continuation or worsening of the oversupply. Although the market did not expect any substantial changes in market dynamics to come out of Doha, the complete lack of agreement signaled that producer countries are not committed to a coordinated approach to balance the market. The negative effect of the non-deal on market sentiment is already visible on the price, with both WTI and Brent benchmarks trading lower since Sunday and with three-month-high trading volumes.

In the short term, the lack of coordinated OPEC action should continue to put downward pressure on oil prices. News on Monday of a loss of 1.7 mbd in Kuwait due to a strike and IEA's new predictions that market fundamentals will balance in 3Q16 have been providing upwards support to the price. Nonetheless, as long as there are no clear signs of market rebalancing in inventories or production numbers, high market volatility will continue to elevate market sentiment as the defining price lever.

Exhibit 2


Long-term market impact

Aside from its immediate effect on prices, in the longer term the deal – or lack of a deal - would have had little to do with rebalancing the market. As discussed before, the participants in Doha are producing at record levels and most have little remaining spare capacity to increase production. In addition, all producer countries are facing mounting budget deficits and reduced revenues due to the depressed oil prices, decreasing their ability to invest in new infrastructure.

Under these conditions, an agreement to freeze production would serve to appease markets but would not have a material effect on production. The market rebalancing, as we have previously reported, will most likely come towards the middle of 2017 through a combination of a natural decline in producing assets, lower US LTO production, and underlying growth in demand.

Exhibit 3


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About the authors

Anders Norlen and Evelina Pagkalou are both senior analysts with Energy Insights in McKinsey's London office.