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Surveys from the likes of Bloomberg showed sell-side commodity strategists were perfectly split on whether OPEC would cut production. However, judging by the 5% collapse in both Brent and US light crude it seems many in the market were positioned for a cut and these traders seem to have reversed their trades.
A number of questions are being asked today: Why hasn’t a cut materialised, what will be the longer-term implications on global economics and, ultimately, where to now for oil?
Firstly, I feel we need to look at the so called ‘break-even’ levels OPEC nations need, in order to balance their budgets. Libya clearly has the highest production costs at $184 per barrel. However, they contribute a modest 2.74% of total production. Iran and Algeria have a break-even rate of $131, while Venezuela and Saudi Arabia have a $118 and $104 rate respectively. Qatar and Kuwait clearly have the lowest production costs so will be a natural benefiter if OPEC can wrestle back market share longer-term.
Comments from the Saudi oil minister convinced the collective to keep prices low and thus squeeze a number of US shale producers. Many of these producers have been increasing production, but a sustained oil price of $65 would alter that radically. There has also been some focus on the friendly relationship shared between Russia and the Assad regime in Syria. Once again, taking on the Russians, who are also a high-cost producer, seems to be the agenda. This move therefore seems to be aimed at taking short term pain for potentially longer-term gain and it is effectively now a game of who will cut first; OPEC or the non-OPEC nations.
It also seems, therefore, that OPEC’s once mighty influence on the oil market is slipping and natural market forces are now much in play. On Bloomberg’s estimates, global oil production is running at just under 31 million barrels, while global demand is running at just over 29 million barrels a day. This tells you the clearest picture about why oil prices have dropped nearly 30% over the last three months.
Still, who are the winners? Firstly the global economy. The IMF calculates that every $10 drop in the price of Brent positively impacts global growth by 0.2 percentage points.
Naturally, we need to look at refiners (such as Caltex), airlines and transporters like DHL. Retail stocks will also benefit, but the positive impact takes much longer to materialise. The losers are naturally the poorer OPEC nations, high cost producers, exploration energy names and companies like Worley Parson who service the energy sector.
On a currency basis, the Norwegian krone has been the best currency to short. This is due not only to the fact that Norway exports over 30% of its total exports in energy; it’s also highly leveraged to the European economy. Canada is also big energy exporter, but 70% of its exports go to the US and as we know its economy is comparatively stronger.
It has to be said that both brent and US light sweet crude are oversold, but the prospect of a material bounce anytime soon seems low.