The big news this morning, excluding further accusations of corruption in football from the Telegraph’s “sting” is an OPEC agreement. (Having always been of the opinion that certain managers didn’t go for the England job as there are no player transfers and hence no “brown packages” to subsidise holidays the Telegraph's findings come as no surprise.) Now what will be a surprise is if the OPEC deal lasts long enough to make a difference to the longer term pricing of crude.
It has been eight years since OPEC last agreed to cut production. This time round a very marginal cut has been agreed, from the current 33.4 million barrels a day (mbd) to the 32.5 to 33.0 mbd range, so 3% at most, Brent still rallied $2.82 on the news to $48.79; just over 6%.
Details are still sketchy, however it appears Saudi Arabia will cut around 350k bpd, which broadly takes OPEC very close to the target range without a cut from other members. Where these agreements have fallen flat in the past has been when the cartel tries to agree individual members’ production quotas, so that any agreement is measurable and thus enforced. It is also thought that Iran, Nigeria and Libya will be outside of any quotas and enforcement; with Iran making it clear it has a target of 4 mbd from its current 3.6 mbd. Call us skeptical, but so far it would appear to be a zero sum gain; nothing has fundamentally changed.
However, Saudi’s new oil minister, Khalid Al-Falih, having only been in position for six months, is trying to change the past strategy of ‘pump at will’; we see this as a positive for future crude pricing. As far as we know any agreement will not be put in place until the official OPEC meeting in November and so we have a couple of months for members to pump up the volume before any quotas come in.
The Saudi led policy over the last two years, i.e. running supply higher than demand, and the consequent fall of crude prices is thought to have created a supply hole further down the road, as the lower crude pricing is believed to have lead to a cut of as much as $1tn in new projects and of course caused many US shale set-ups to head into bankruptcy. This is thought to paint a better financial position for the OPEC member countries in the longer term. In the near to medium term however, world growth and a pickup in demand, which we feel is unlikely, combined with much larger production cuts and an agreement with non OPEC members such as Russia, Mexico and Norway is the only way to send crude up ambove the $60 price on a sustained basis.
So, we believe it is very unlikely that the benign inflation outlook will be influenced any time soon from increases in crude prices.