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Russia and Opec cut: false hopes

, January 29, 2016

By Michael Cohen
The talk of an Opec cut is likely no more than an attempt to shift market sentiment, according to an expert, who remains skeptical about a change in the physical market imbalance.
 
Michael Cohen, head of Energy Markets Research at Barclays, said this following announcement by media outlets about the possibility of an Opec meeting next month, and Russian Energy Minister Alexander Novak's willingness to take part in it.
 
Iraq, Qatar, and Oman have stated their willingness this week to entertain a meeting to discuss output cuts. 
 
Given the extreme short positioning of net managed money, this news has spurred positive price action this week. 
 
There is a vast difference between a meeting to exchange views on the state of the markets and a meeting to agree on a cut, said Cohen.
 
This will likely be the former, not the latter. The officials will meet to reassure themselves that there is a light at the end of the tunnel, that non-Opec supply is already falling and expected to fall further, and that if they can just see themselves through the first half of the year, the balance will tighten from then on, he said.
 
The Russian government has only very blunt tools to administer a cut in production, and a political decision to work with Opec to cut supply is far from confirmed. 
 
Novak has the authority to work with the Finance Ministry to adjust the Russian Mineral Extraction Tax, but we see no historical precedent for Russian cuts, and this time is no exception. 
 
Though Rosneft chairman of the board and Putin ally Igor Sechin attended the Opec meeting in November 2014, no cuts were agreed.
 
President Putin’s press secretary, Dmitry Peskov, was quoted as saying this week that 'consultations and exchange of views' with Saudi Arabia and other producing countries on the oil markets situation are taking place 'on a constant basis.' 
 
However, 'the issue has not been touched upon on a practical level.'
 
Russia will continue to do what is in its best interest. 
 
From Russia’s standpoint, it sees no downside risk to calling a meeting, especially if doing so results in changing the market sentiment and how the market perceives Opec’s willingness to cut. 
 
Russia has been and will continue to be involved as an observer country. It has been holding regular discussions with Opec members on the market, and Novak’s ministry is the entity within the Russian government charged with participating in such dialogues. 
 
The part of the rationale for Russia to sound a more amenable tone can be seen in the context of its growing international isolation due to sanctions, its policy in Syria, and complications in extricating itself from Eastern Ukraine. 
 
Its willingness to participate could therefore be seen as part of its need to highlight to the international community that it can be useful and that it is relevant.
 
From a physical standpoint, it is difficult for Russia to turn on and off reservoirs without major complications, but some production decline is already underway, said Cohen.
 
About 90 per cent of Russia’s output comes from seven major producers, but almost 90 other companies produce the rest. Russia’s production is already reacting, he said.
 
Lukoil’s West Siberian fields’ decline rate has accelerated. Moreover, further cuts during the winter are highly unlikely, since it would bring about a near-permanent loss in the ability to produce from Russian wells. 
 
The chairman of the committee on economic policy of the State Duma, or lower house of the Russian parliament, Anatoly Aksakov noted recently that 'At certain levels of prices, production from separate wells at separate fields becomes loss-making. 
 
In this sense, production may be suspended. This underlines the point that other companies have made by cutting investment in new output.
 
Opec's inability to arrive at a credible path to a cut will undermine its ability to accelerate the market balancing process. 
 
Cohen sees it as a hard sell for Saudi Arabia and Russia as well, to agree to cut production, while Iran continued to ramp up output.
 
We see it as a hard sell for Saudi Arabia (and Russia, for that matter) to agree to cut production, while Iran continued to ramp up output. 
 
Beyond this risk of losing market share to its arch rival, a swift, sharp recovery in prices also risks the repeat of the second quarter last year, delaying the balancing process in the oil market, as non-Opec producers that were on the verge of getting squeezed out get breathing room, and a higher price delays the process of putting the global economy on more stable footing. 
 
In our view, the price path implied by forecasts, of Brent trading less than $40 per barrel for at least two quarters, is required for the balancing process to take place, paving the way for a more sustainable increase in prices.
 
In addition to Russia, other non-Opec producers are highly unlikely to commit to anything other than ‘officialising’ the production declines that have already occurred. 
 
Non-Opec ex-US producers that have already done so are Mexico, Azerbaijan, Kazakhstan, Indonesia and Colombia.
 
Iraq may also be able to say that it is officialising an impending slight decline in its output this year, given the rapid contraction in drilling activity. 
 
Should non-Opec producers other than Russia participate in the meeting, their ‘contribution’ to any cut will be in the format of business as usual, meaning that they are highly unlikely to do anything besides point to expected reductions in production that occurred in 2015 or will occur in 2016. - TradeArabia News Service
 
 
Michael Cohen is the head of Energy Markets Research at Barclays



Tags: Energy | Oil | Opec | Barclays | Output |

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