We were not particularly surprised by OPEC’s decision to prolong its current policy of production cuts through the end of 2018. Rhetoric from all sides (most importantly Saudi Arabia and Russia) leading up to yesterday’s meeting was highly suggestive of the nine-month extension. A new cumulative limit was placed on Nigerian and Libyan production, but at a level above current combined output for both countries. Comments by OPEC ministers were constructive, albeit consistent with their quotes prior to the official announcement, calling for a continuation of the cuts and eventually a “gradual” exit from the policy. OPEC views last November’s historic “Declaration of Cooperation” (where an OPEC+ committee was formed with the inclusion of Russia) as working effectively to reduce global crude inventories to its goal of the five-year average. It estimates excess OECD inventories have been lowered to 140m barrels, down 200m barrels from the beginning of the year (the start of the policy) and 140m barrels from the May OPEC meeting. Nevertheless, with excess supply still in the system, it states a continuation of the 1.8m barrel/day production cut is needed, especially headed into the seasonally weaker global demand period.
While the OPEC meeting was uneventful compared to a year ago, we believe it was important in moving past what has been an overhang for many oil-related equities. Since April of this year, the weekly DOE inventory reports have shown consistent draws, indicating a market that is tightening at a rapid pace. (See our Oct. 12 blog, “Oil: It’s Getting Tight in Here”.) Nevertheless, many energy equities have remained in the doldrums, even despite significantly improved crude prices in recent months. This disconnect contrasts a historically high correlation between crude prices and the stock prices of upstream companies (E&Ps and service providers), and we believe in part has reflected investor trepidation regarding risks surrounding OPEC’s renewal and ultimate exit of its policy. Therefore, with the production cuts now officially extended through 2018, we believe investors can focus on the improving supply/demand picture for crude oil and our expectation for more positive sentiment for energy equities.
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