The skeptics had it wrong! Saudi Arabia and Russia secured what the Saudi oil minister says correctly is a “historic deal" with non-OPEC nations. This deal can only be described as a major diplomatic achievement and was done despite long odds. Not only was Saudi Arabia and the Saudi oil minister Khalid Al-Falih able to put aside their animosity with Iran, they were also able to get Iran to commit to a ceiling on its output. Russia and Vladimir Putin helped orchestrate a deal with non-OPEC nations for the first time, adding to OPEC’s 1.2 million barrel a day cut.
Because of Russia's success sealing the deal with non-OPEC nations, the Saudi oil minister put the icing on the cake by saying, "I can tell you with absolute certainty that effective Jan. 1 we’re going to cut and cut substantially to be below the level that we have committed to on Nov. 30. If the market demands it, we are ready reduce our output under 10 million barrels a day.”
Despite the skeptics, I predicted this outcome all along even as the negotiations had its series of ups and downs. I believed strongly that the deal to cut output would happen because the time was right. Two years ago on Thanksgiving, the last OPEC deal fell apart when then OPEC Secretary ALI Naimi could not get a firm commitment from Russia and Iran to cut production and a production war was declared. The Saudis hoped to drive shale producers out of business and at the same time, price some sense into other non-OPEC and OPEC producers. The move was not a total victory over the shale producers but it was enough to force many of them into bankruptcy and slow the metoric rise of US output. And while it is possible that the OPEC move will help the shale producers rise output next year, OPEC and non-OPEC have enough of a lead with market share that it would not be a threat, at least over the next few years.
We did see U.S. rig operators already respond in part because of higher prices and year-end lease obligations. Baker Hughes reported that the U.S. oil rig count increased by 21 rigs to 498, the biggest increase since July, 2015. They also reported an increase of 6 gas rigs to 125. The increased drilling may slow a bit in the new year but the OPEC move may loosen up some more appetite for investments.
The OPEC deal basically ensures that the global oil market will be in a deficit in the new year. We will then start to drawdown global stockpiles. As I said before, this could mean that crude oil may hit $60.00 a barrel by the end of this month or early next year and we could see a return of oil back towards the eight-dollar handle sometime next year. Shale operators and other producers that are too quick to hedge may regret it in a couple of years. There will be a tendency and perhaps a demand that they take what they can get today and forgo what could be significant upside in prices in the coming years.That means we will see gas prices and heating-oil prices edge higher as well.
Natural gas on the other hand backed off big as it might not be as cold as some have predicted. Still even with normal cold we may find that draws come in much higher than expected over the next few weeks. We still like the long side.