OPEC maintained its 30mmb/d target and refused to cut production. GCC oil ministers stated that oversupply was not OPEC's problem; the market will ‘fix it’ and new high-cost non-OPEC production must now play a role in balancing the market. This effectively suggests OPEC is happy for prices to fall as low as needed to curtail growth in US tight oil production.
We believe OPEC has essentially initiated a price war with US tight oil supply, challenging the market to set oil prices at the level at which it becomes seriously threatened and is substantially curtailed. This is the only conclusion that can be made from yesterday's OPEC meeting and subsequent press conference, in our view, as OPEC rolled over its 30mmb/d production target despite conceding that the market was oversupplied. Furthermore, despite IEA forecasts that the call on OPEC crude in 1H15 will be 28.75mmb/d, and OPECs own forecasts that it will fall to 28.5mmb/d in 2016 and 28.2mmb/d in 2017, OPEC's secretary-general answered (almost every question) with the words that the cartel will produce 30mmb/d in 2015, and wait and see how the market reacts. There was no concession of any sort, an adamant refusal even to consider production cuts, and a clear message that OPEC is prepared to see prices go (potentially much) lower.
After the meeting concluded Brent prices were effectively in free fall, down more than USD 5/bbl in just the first 90 minutes after the meeting concluded to a low of USD 71.55/bbl (-6.5%). We think it is now inevitable prices will fall below USD 70/bbl, with a serious risk of a decline to USD 60/bbl, or even lower, before year-end. Furthermore, with OPEC so adamant about not cutting output and leaving the market at the mercy of speculative fund short-sellers, the outlook for 2015 is increasingly bearish with a growing risk of an extended period of sub-USD 70 pricing.
However, we believe OPEC might be underestimating the determination of the US to maintain its new found energy independence, and hence its willingness to support tight oil growth. Many industry experts have estimated the WTI clearing price for US tight oil at USD 65-75/bbl, and this clearing level is falling quite rapidly as efficiency and productivity improvements are steadily implemented. However, with WTI fast approaching USD 65/bbl, this could soon be tested. Recent industry estimates have also suggested that US tight oil supply growth could be 50% lower (500-700kb/d) in 2015 if WTI prices were to average USD 70/bbl, with a similar slowdown in 2016 if prices were to remain at these levels. While this would clearly help the market balance, it would not offset the 1.5-2.0mmb/d surplus that is now widely expected in 1H15 if OPEC sticks to its 30mmb/d target.
We are therefore in a price war situation, in our view. Commodity price wars are damaging and potentially dangerous, and there are no winners. While the GCC countries clearly have enormous financial reserves after four years of high prices, and these are likely to last much longer than most market estimates, there is still a growing risk of significant damage on both sides. Investors should certainly prepare for a volatile year-end in oil markets.