Orlando's Outlook: OPEC extends production cuts


Bottom Line As we approach the Memorial Day weekend, marking the unofficial start to summer, we’ve suffered through a colder, wetter spring than normal here in the Northeast, leaving many with a bad case of cabin fever. As a result, more than 39 million Americans are expected to travel away from home this holiday weekend, a 12-year high, according to the national motor club AAA. Despite gasoline prices that are 40% higher than last year’s February trough, the economy is firming and consumer confidence is strong, which should lead to higher levels of consumer spending. Just this morning, for example, the Department of Commerce revised disappointing first-quarter GDP up from a muted 0.7% increase to a 1.2% gain, and we’re expected a much stronger 2.6% jump (with an upside bias) in the current second quarter. In addition, Michigan’s consumer sentiment index for May was just finalized at 97.1, which is only marginally below January’s 13-year high of 98.5.

Happy Memorial Day weekend, everyone!

U.S. travel trends point to stronger economic growth this summer According to our friends at AAA, 39.3 million U.S. travelers will take to the roads, skies, rails and water over the Memorial Day weekend, which is a 2.7% year-over-year increase and the strongest travel metrics since the 3-day holiday weekend in May 2005.

  • Most travelers (34.6 million) will drive 50 or more miles to their destinations. Rental car bookings are 19% higher than a year ago and prices are up 7%. The average price nationally for a gallon of unleaded fuel is $2.37, nearly 40% higher than the cyclical trough of $1.70 per gallon hit in February 2016.
  • Airports will be busy, as 2.9 million people will fly somewhere, a 5.5% increase over the last Memorial Day. Average airfares for the 40 most popular domestic destinations are up 9% over last year.
  • Other types of transportation, such as cruises, trains and buses, are popular among another 1.75 million travelers, representing a 2.9% increase from a year ago.
  • When they get to their destinations, people will find average hotel prices of $215 per night (exclusive of taxes) for those with three-diamond ratings, a spike of 18% from a year ago.

Vienna deal a success Against this Memorial Day weekend backdrop, the 13 oil-producing nations that comprise the Organization of the Petroleum Exporting Countries (OPEC)—in conjunction with 11 non-OPEC oil-producing nations (including Russia)—agreed in Vienna yesterday to extend for another nine months (into March 2018) their joint production cut of 1.8 million barrels a day. This reduction in crude-oil production, OPEC’s first coordinated production cut in eight years, went into effect at the beginning of 2017 and is beginning to positively impact a global oversupply of oil. In terms of the mix split, two-thirds of the cut (1.2 million barrels per day) is coming from the OPEC side, with Saudi Arabia shouldering most of that burden, and one-third (600,000 barrels) is coming from the non-OPEC countries, with Russia ponying up half.

Buy the rumor, sell the news In anticipation of this favorable outcome, crude oil prices (as measured by West Texas Intermediate) had soared nearly 19%, from an oversold $44 per barrel on May 5 to an overbought $52 on Wednesday, before profit taking yesterday took crude prices back down to $49, in classic “buy the rumor, sell the news” fashion. In fact, some market participants had expected that, if OPEC was publically discussing a nine-month extension, then the final extension might be a year or longer, which evoked some disappointment among investors.

Focus on storage Oil storage has become an important focal point in analyzing the global glut of crude oil and the impact that a supply/demand imbalance has on pricing. OPEC’s coordinated plan (with non-OPEC support) to continue reducing production by 1.8 million barrels per day amounts to only about 2% of global oil supply, as OPEC’s global market share over the years has shrunk to about one-third. Part of the problem is that over the course of last year, anticipating that some sort of a production accord was necessary, participating oil producers ramped up their own production to maximum levels, expecting to agree to some cut from these elevated levels. Consequently, the market became oversupplied, and stored crude oil has only recently begun declining.

OPEC’s stated goal is to reduce storage levels for its industrialized nations back to 5-year average levels. Last November, however, before the first accord was put into place, OECD oil stocks were a bloated 300 million barrels above the 5-year average. This past March, that glut has shrunk only 8% to 276 million barrels. So there’s still much work to be done, which is why the production cuts were extended until March 2018. At the current pace of production, and assuming constant demand, it could be three years or longer before the storage goals are fully achieved.

New teams on the field Yesterday, OPEC announced that Equatorial Guinea, one of Africa’s largest oil producers at 227,000 barrels per day at the end of 2016, had joined OPEC as its 14th official member. In addition, two more non-OPEC oil producers, Egypt (at 490,000 barrel per day) and Turkmenistan (245,000 barrels per day), have joined the accord. Consequently, this new wider field of 27 OPEC and non-OPEC producers collectively control about 52 million barrels per day of production, according to the Wall Street Journal, or about 60% of estimated world demand of 87 million barrels.

Noncompliance That’s a helpful offset, as Nigeria (at 2.7 million barrels per day) and Libya (700,000 barrels per day) remain exempt from any cuts due to their own country-specific problems, so they can continue to ramp up production. Moreover, Iran (Saudi Arabia’s long-time nemesis, which produces 4.3 million barrels per day) and Iraq (4.4 million barrels per day) argue that they should be entitled to higher production quotas due to years of underperformance from economic sanctions. So the risk of potential cheating among some participants from agreed-upon quota levels remains high.

Russia is a motivated non-OPEC player Russia remains the largest crude-oil producer in the world, currently at 10.7 million barrels per day. Declining oil prices from $108 in 2014 to $26 in 2016 pushed their commodity-centric economy into recession. But according to the Wall Street Journal, Russia’s budget improves by $30 billion for every $10 increase in the price of crude oil. So with Russian President Vladimir Putin planning to run for re-election in 2018, Russia has pledged to cooperate with the OPEC cuts, contributing their own 300,000-barrel-per-day reduction.

Draghi-esque ‘whatever it takes’ At 10 million barrels per day, Saudi Arabia is the world’s second-largest crude oil producer and the largest within OPEC. It has taken a leadership position here, cutting its own production by nearly 700,000 barrels per day from last summer’s peak production levels. Why so motivated? In our view, the Saudis remain desperate to engineer higher oil prices of perhaps $60 per barrel next year or higher to facilitate the successful initial public offering (IPO) of a 5% stake in its national oil company, Saudi Aramco, whose value approximates $2 trillion and that could raise $100 billion to help balance its budget deficit.

U.S. a fly in the OPEC ointment The U.S. is the world’s third-largest crude producer with about 8.9 million barrels of oil produced each day, down from peak oil production of about 9.6 million barrels per day in in the summer of 2015. As the price of crude oil collapsed from 2014 to 2016, uneconomical wells were shut down, such that the land-based domestic rig count (for both oil and gas) plunged from a peak of about 1,900 rigs at the end of 2014 to less than 400 in the second quarter of 2016. But with the price of crude doubling over the past 15 months, the rig count has soared back to 874 this month and fracking operators have learned to become much more efficient that they were just a few years ago.

Consequently, U.S. energy companies have benefited significantly from the recovery in the energy market, they are not part of the OPEC production cuts, and they have no intention of restraining production. As a result, with Russia and Saudi Arabia holding back their production levels for their own reasons, some industry experts believe that the U.S. could become the world’s largest crude producer over the next several years. That incremental U.S. supply will likely restrain prices, given constant demand, as we do not expect crude-oil prices to revisit elevated 2014 levels.

Trump to open SPR floodgates? As part of his preliminary 2018 federal budget, President Trump has proposed selling off a third or more of the U.S.’s strategic petroleum reserve of some 700 million barrels of crude oil, which is stored in salt caverns in Texas and Louisiana in the event of a global energy crisis. We think that’s a bad idea, and we don’t think that Congress will ever approve his suggestion. In addition, flooding the global market with 300 million barrels of crude oil over a decade would certainly upset the fragile supply/demand pricing balance that the OPEC cuts have orchestrated, at least temporarily, as well as our domestic energy production, which is raking at present.

Trump has also proposed opening up more federal land for oil and gas drilling to raise revenues, and to shrink the spending for the Energy Department, as a means of helping to balance the federal budget, which are marginally better ideas.