26 June 2018Oil Desk Note2 GlobalMarkets.bnpparibasOPEC or the art or the dealHowever, the geopolitical atmosphere heading into OPEC’s 174th ordinary meeting was heavilycharged with Iran, the organisation’s third largest producer, under unilateral US sanctions. Theextra-territorial reach of US law however implies that Iran’s oil exports, and subsequently itsproduction would ultimately be highly crippled before year-end. Venezuela, an OPEC foundingmember, is also facing US administration pressure albeit with sanctions directed at members ofthe Maduro Administration and state oil company PDVSA rather than directly at its oil industry. In any negotiated outcome, there is a degree of posturing before compromises are made thatpave the way to a deal. OPEC meetings are famous for such posturing and there was noshortage of posturing from Iran. Iran came to Vienna with a very entrenched position, backed byVenezuela and Iraq, opposing even modest increases in supply. In addition, Iran sought officialOPEC condemnation of US sanctions targeting its oil production. In the time between OPEC’s7th international energy seminar and the ordinary OPEC meeting on Friday 22 June, Iran stancewitnessed a few volte-faces. But in the end, Iran agreed to a deal. Iran’s antics before and afterthe OPEC meeting can easily be interpreted in the context of the need to politically assuage itsdomestic base. With an increase in production “inevitable” in the words of Al-Falih, the realquestion was how to bring Iran on board and therein is found the art of the deal. OPEC agreed on Friday 22 June a collective production increase without mentioning specificsin terms of volume or allocation between member countries. Only a return to compliance withthe originally agreed supply cuts was announced and stressed. The official press communiqueindicated that “the Conference hereby decided that countries will strive to adhere to the overallconformity level of OPEC-12, down to 100%, as of 1 July 2018 for the remaining duration of theabove mentioned resolution and for the JMMC to monitor and report back to the President ofthe Conference”. The elusiveness of details has frustrated market observers. From verbalcommunication, it was inferred that a nominal increase in production of 1 mb/d was agreed.However, the amount of increase that would effectively be delivered over the next months wouldprove lower as only a handful of member countries have spare production capacity. In thisrespect, a consensus formed around a 600-700 kb/d increase with the bulk of the incrementcoming from Saudi Arabia, with lesser contributions from Kuwait and the UAE. During the press conference, OPEC President (and UAE energy minister) Suhail Al Mazroueirepeatedly avoided questions relating to production allocation, focusing time and time again hisremarks and answers on compliance and this for good reason: optics matter greatly. Whileobfuscating the interpretation of the deal, the lack of allocation details is in our view whatallowed for the deal to happen. To get Iran on board, given the country faces downside supplyrisk over the next 6 months, it would have been diplomatically infeasible to allocate to any oneother OPEC member country a rise in output that could have been perceived as a takeover ofIranian market share. The same goes for Venezuela. A solution focused on conformity aloneultimately proved satisfactory for Iran with its oil minister Bijan Zanganeh quoted by pressagency Shana today as saying that OPEC’s agreement did not contain a production increase.He further added that Iran’s suggestion was to first balance oil in the market, secure members100 percent compliance to the agreement, and then decide on a production increase in nextmeeting if needed.OPEC+ endorses OPEC’s agreement and reaffirms 100% compliance OPEC met with its ten allied non-OPEC countries on Saturday 23 June. The combined groupcommonly referred to as OPEC+ quickly endorsed OPEC’s Friday accord. Once again theofficial press communique emphasised the need for conformity, indicating that “the 4th OPECand non-OPEC Ministerial Meeting hereby decided that countries will strive to adhere to theoverall conformity level, voluntarily adjusted to 100%, as of 1 July 2018 for the remainingduration of the DOC (Declaration of Cooperation)”.At the Saturday proceedings, Saudi energy minister Al-Falih said that “We will do whatever isnecessary to keep the market in balance”. He also had reassuring messages for consumingcountries indicating that “their energy supplies are available, are being stewarded by aresponsible group of producers.” This may be interpreted as Saudi Arabia heading the call ofconsumers, with the Kingdom intent on not letting oil prices rise too high. At the same time, theobjective to preserve a balanced market also suggests that producers will act to ward off theemergence of any new oil supply surplus. OPEC+ reaffirms the needcompliance while omittingvolume targetsThe art of the deal:overcoming Iran’soppositionOPEC agrees a collectiveoutput increase but givesno specificsOptics matter greatly 26 June 2018Oil Desk Note3 GlobalMarkets.bnpparibasAl-Falih did however expand on the output increase, offering the following guidance, If weallocated the number on a pro-rata basis among the 24 countries, given the capacity of thosecountries that can increase, it had been estimated that about 60 percent will be achieved”. “Butbecause we went away from allocation on a pro-rata basis, we will be closer to 1 million than to600,000 barrels a day. How may a 1 mb/d production come about Saudi Arabia in May was producing a little over10 mb/d but we think it can readily lift crude supply by 500 kb/d in the next three months,essentially restoring output towards the 10.5-10.6 kb/d produced on average in the last quarterof 2016. The expansion of the OPEC accord to OPEC+ gives rise to the opportunity for Russiato increase output by 200 kb/d. Lastly, Kuwait and the UAE combined can provide a further 200- 250 kb/d. How quickly such increases can be achieved remains to be seen. Preliminary figuressurveyed by Petro-logistics SA for June indicate that OPEC crude exports rose by 1.1 mb/dover May, driven by Saudi Arabia, Kuwait, the UAE and Qatar. A production increase may wellbe already underway, complemented by sales from storage. UAE exports are estimated to haverisen by 760 kb/d while those of Saudi Arabia climbed by 590 kb/d. In the case of Saudi Arabia,Bloomberg reports today that the Kingdom’s crude production may hit 10.8 mb/d in July.However, part of the production increase will be domestically absorbed by the seasonal summerincrease in utility direct burn.Implication for the oil price outlookBefore OPEC met with non-OPEC on Saturday 23 June, the Friday OPEC decision wasperceived by the market to translate into an effective increase in output of circa 600-700 kb/d, oran amount that was deemed too little to tilt the oil balance into bearish territory. This increase,when juxtaposed with lower OECD oil inventories and abundant risk to supply, was seen asinsufficient to prevent a tightening in market conditions, so the market rallied. With the OPECagreement expanded to non-OPEC countries over the weekend with a 100% group complianceobjective clearly emphasised, the perceived forthcoming increase in output rose closer to1 mb/d. As a result, oil prices fell yesterday, notably in Brent the global benchmark and were stillstruggling this morning. The market’s bearish reaction was a little surprising considering thatdespite a supply increase, output restraint will remain in place until the end of the year, limitingthe market’s ability to rebuild an inventory buffer while mechanically seeing spare productioncapacity decline.By the end of the year, with US sanctions, we think that 800 kb/d or more of Iranian exports maybe taken off the market, which inevitably will lead to a decline in production when onshore andfloating storage become saturated. Today, a State Department briefing on Iranian sanctionsindicated that the US would like to see allies reduce their imports of Iranian crude oil to zero by4 November. In the meantime Venezuela remains a wild card. Venezuela’s reference level ofcrude production was pegged a little over 2 mb/d. The country now produces only 1.4 mb/d. TheIEA reckons that the worsening state of Venezuela’s oil sector could lead production to fall to1 mb/d by year-end. Finally in Libya, after heavy damages were inflicted to storage facilities atthe key oil terminals of Ras Lanuf and Es Sider, crude oil output losses are thought to amountto 450 kb/d. Given the damage to infrastructure, Libyan supply losses are likely to be sustainedfor several months. Tallying the outages above would suggest that net increase in supplyafforded by OPEC+ would still leave the oil balance in deficit with implied global stocks changespointing to draws in Q3 and Q4 2018.Turning to US shale oil, that accounts for the bulk of non-OPEC supply y/y growth this year andnext, its ability to play a role alongside OPEC+ in offsetting losses described above may belimited. Further growth in shale output, notably in the Permian Basin, will be hard to come bygiven constraints in pipeline capacity to take oil from fields to the distribution, refining or exportcentres. Further increments to growth are only likely to take place when these constraints beginto lift in 2019. Scott Sheffield, CEO of Pioneer Natural Resources was quoted as suggestingthat wells may even need to be shut-in because of the inability to transport additional oil. Add it all up and the barrel math in our opinion is still supportive for oil prices over the next 6months and we would not be surprised if Brent were to trade once again above USD 80/bbl, aleast until such time the pipeline constraints in the US are lifted in 2019 and US exports furtherexpand, reaching amongst other, Asian markets typically supplied by OPEC’s Gulf producers. Supply restraints remain inplace until the end of 2018,limiting the market’s abilityto rebuild an inventorybufferSaudi Arabia providesguidance on OPEC+decision to increaseproductionThe barrel arithmeticremains supportive for anincrease in oil pricesSupply losses in Iran andVenezuela are likely to besubstantial, offsettingincreases in OPEC+ supply 26 June 2018Oil Desk Note 4 GlobalMarkets.bnpparibas Legal NoticeThis document has been written by our Strategist and Economist teams within the BNP Paribas group of companies (collectively“BNPP”); it does not purport to be an exhaustive analysis, and may be subject to conflicts of interest resulting from their interactionwith sales and trading which could affect the objectivity of this report. 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