OPEC Decision: Same Old Tale…Different Outcome

Oil & Gas
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Friday, December 08, 2017 / 9:50 AM /ARM Research 

OPEC roars back to show she hasn’t lost that old magic
The cartel and its allies stood together and agreed to extend its production agreement (‘Declaration of Cooperation’) until December 2018 and have scheduled June 2018 to assess the market and evaluate its agreement. 

Saudi Arabia and Russia, the key players, reinforced their alliance to comply with the agreement. 

More importantly, Nigeria and Libya have now been included in the agreement. Both countries are expected to limit production to 2017 high which informed the cap on their collective output at 2.8mbpd (excluding condensate). 

Assuming Libya produces at its 2017 peak of 1.01mbpd, this implies Nigeria’s production should hover around 1.8mbpd which is ~2.1mbpd (inclusive of condensate).  

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Stronger cooperation – member’s interest are well aligned
Key players are maintaining a robust engagement to improve structural factors of the industry, leaving aside certain differences in foreign affairs (e.g. Saudi Arabia and Iran). 

Russia has aligned its objectives towards the agenda, protecting the investment plans with Saudi Arabia, especially after the recent visit of Saudi King last month. 

Joint Ministerial Monitoring Committee (JMMC) has successfully ensured that the ‘Declaration of Cooperation’ is achieved through the successful implementation of voluntary adjustments in production. 

Wide-ranging commitment to a lasting stability in the oil market – in the interest of oil producers, consumers, and the industry.  

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US increasingly pumps as hurricane impact cools off
US production continues to rise, though slower than expected on the back of recent tropical storm. 

Consensus forecast of a rise in US oil production to ~10.5mbpd was cut short by impact of hurricane. 

Much of the rise has come entirely from unconventional (or shale) oil sources, supported by a recovery in oil prices.  

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The two biggest shale oil fields (Eagle Ford  and Permian) which account for 90% of total unconventional production recorded a 14% and Technological advances have supported increased efficiency in shale oil production. Production now seems resilient to crude oil prices below $50/bbl. 

The recent uptick in prices has seen a return in hedging activity - data from E&P companies which account for around 75% of total US shale oil production shows a steep rise in hedges in the last few months.  

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Supply narrative still implies a tighter oil market
The balance between OPEC’s commitment to its production cut deal and US oil production continues to shape the supply 

U.S. oil production moderated the impact of the current deal - nearly 55% of the cut was filled by US oil supply.  

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Demand - a key driver for the rebalancing path
Demand dynamics have been particularly strong this year amid a robust global economic performance.

Global economic growth has been supported by the developed nations, a reflection of manufacturing activity recovery, positive consumption, and confidence hitting new highs. 

China’s demand has been very resilient this year on the back of upbeat economy. Increasing gasoline and jet fuel demand alongside rising LPG and fuel oil demand, accounted for the bulk of these gains. 

To add, India’s oil demand rebounded as data reveals that India’s economic growth is picking up after the disappointing Q2 17 performance. 

Overall, global oil demand has increased by 3% (+2.7mbpd) from the start of the year to 98.7mbpd.  

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OPEC reference indicator – visible inventories depletion
OPEC reference indicator, the OECD commercial inventory, has depleted at an accelerated pace in recent months supporting the rebalancing process 

Crude inventories have sustained its convergence towards OPEC’s explicit 5-year average objective.

Significant unplanned supply disruptions also supported further inventory withdrawal.

Among these, September’s hurricanes severely affected the U.S. Golf Coast.

Moreover, Mexican output took a hit from Harvey and Katia storms as well as the earthquakes during the same month.

The destocking process, both onshore and offshore, has continued at an accelerated pace in recent months – OPEC

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The hope of rebalancing looks set to garner momentum
From the demand perspective, crude oil demand has outstripped supply this year as global economic growth remains firm. 

We forecast global oil demand growth of 1.3mbpd reflecting improved demand from key consumers - OECD Europe, OECD Asia, China, and India.

OPEC and EIA forecast a global oil demand growth of average 1.5mbpd. IEA recently lowered its demand forecasts. However, the base of the adjustment is still high when compared to previous years and is keeping a higher course for 2018.

On Supply, we expect higher compliance by OPEC and non-OPEC members to the production cut hinged on strong commitment shown by Russia and Saudi Arabia

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However, inherent risk largely stems from US production.

On this basis, we expect the impact of higher prices and increased hedging activity to drive increase in US production. Consequently, we forecast an average output of 9.8mbpd for 2018 from ~ 9.2mbpd in 2017

This implies that ~65% of production cut by OPEC will be offset by higher production from the US.

This will lead to a seasonally adjusted deficit of 100kbpd in 2018.

Crude oil prices in 2018 will consolidate to ~$60/bbl.
The extension of the production cut deal through the end of 2018 is sending a stronger signal that the oil market rebalancing could speed up and send oil prices higher. 

Given our view on a faster pace of market rebalancing, the effect of U.S. production rising given higher prices could be relatively contained by the futures’ curve term structure which would offer less attractive conditions to hedge.

Furthermore, speculative position could have a greater influence in the short-term than market fundamentals.

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Inherent risks are skewed to the upside - the risk of an overtightening due to further disruptions, higher compliance by OPEC, and demand exceeding our conservative forecast

Based on the foregoing dynamics, we envisage the rebalancing process of the crude markets would leave 2018 prices stable, albeit slightly lower in H2 18.

Given the interpolation between changes in net supply and Brent crude, we update our crude oil forecast to $55/bbl.  -  $65/bbl.  With a base case of $61.50 for 2018 (previous forecast $50/bbl.$55/bbl.)

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Impact on Domestic Economy

Nigeria’s production will increase notwithstanding output cap
No cause for alarm on the combined production cap of 2.8mbpd for Nigeria and Libya. 

Assuming Libya produces at its 2017 peak of 1.01mbpd, this implies Nigeria’s production should hover around 1.8mbpd which is ~2.1mbpd (inclusive of condensate).

Crossing 2.mbpd for Nigeria is very unlikely considering minimal investment in the E&P sector recently. However, the JV cash call restructuring may provide some support to production.

The risk to Nigeria largely stems from political risk and the possibility of militant attacks as we gear towards electioneering.

On this basis, we hold a conservative view on Nigeria’s production at 2.0mbpd

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We estimate an average of $1.2 billion monthly in oil inflow
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Looking at historical trend in Nigeria’s production and crude oil prices alongside oil inflows, we sleuth for clues and conclusion.

In the period where Nigeria’s production hovered around 2mbpd alongside 
~$60/bbl., monthly oil inflows averaged $1.2 billion. 

Coalescing our analysis with historical trend, we forecast an average oil inflow of ~$1.2 billion monthly over 2018.

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However, should oil prices trend at our bear case of $50/bbl., keeping production estimate unchanged, monthly oil inflow should print at ~$900 million over 2018.

Also, assuming our bull case for oil prices at $70/bbl. while keeping production estimate unchanged, monthly oil inflow should print ~$1.8 million over 2018.

Lagged impact of export proceeds suggest oil rebound
Accretion to the external reserve has largely been driven by non-oil inflows to the CBN as well as swaps. 

The lagged impact of export proceeds to oil inflow guides to increasing oil inflow in coming months and in extension accretion to the external reserve.

Despite significant outflows from the CBN in recent months, inflows continue to track higher to keep net flows positive.

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Net autonomous flows was also sizable to offset likely shocks on the CBN net flows

Going forward, we expect some moderation in autonomous flows on the back of lower yield environment and impending political risk.

Consequently, we think the CBN will be the largest FX supplier over 2018, and thus expect steep depletion in the FX reserve from H2 2018.

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FX Reserve should cross $40bn but depletion is in the cards
According to the media, the CBN disclosed that the external reserve has reached $38.2 billion with the accretion coming from $3 billion Eurobond recently issued. 

Given past Eurobond Issuance which was not captured in the CBN cash flow account, we have discounted this inflow and based our analysis on primary sources – Oil and non-oil inflow.

Based on our analysis, we expect the FX reserve to hit $40 billion by Q2 2018. However, adjusting for the Eurobond proceeds of $3 billion suggest FX reserve forecast of $43.5 billion over the period.

That said, given our basis of capital flight over H2 2018, we expect a steep depletion in the reserve of ~$2 billion.

On balance, our expectation of a depressed outlook on autonomous flows will have a mild impact on the currency market given accretion in CBN’s war chest to sustain liquidity.

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Fiscal outlook may drift in line with proposed budget
At $60/bbl. for the Brent, oil revenue projections may likely run ahead of budgeted revenue by N559 billion, despite our 2.0mbpd production relative to 2.3mbpd on the proposed budget. 

However, we think non-oil revenue will be shy from projections, bringing total revenue projections lower by N884 billion.

We have assumed budget implementation of 90%.

Overall, we project fiscal deficit at N2.0 trillion – in line with proposed budget.

Assuming 100% budget implementation, deficit should print at N2.9 trillion.

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How will this shape FG borrowing plan?
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