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OPEC has agreed to an effective ~0.6MM Bbl/d production increase that will eliminate the “over compliance” or “under production” relative to the original quota struck by OPEC in 2016. I would remind you that Venezuela continues to implode (falling 60,000Bbl/d per month) and the impact of Iranian export restrictions is just beginning to be felt (likely to ultimately amount to a ~1MM Bbl/d loss of exports) so today’s increase will likely not fully offset these two factors and as such the oil market should continue to further tighten. Today’s announcement is the best case scenario for the oil market.
Today’s announcement also has a more subtle and less obvious bullish signal. Why is OPEC now increasing production? It is simply because the oil market is extremely tight/undersupplied and OPEC acknowledges the trend that we have been writing about over the past several months: inventories were on a path to go from a 330MM barrel glut (January 2017) to a 325MM barrel deficit by December 2018 and would likely have resulted in a price spike (not in anyone’s best long term interests). Our initial take at modelling the incremental production now suggests that the deficit relative to the 5 year average will hit 250MM Bbls by YE’18 versus 325MM barrels previously. As today’s action simply moves some of the barrels that we had assumed would come online in 2019 to late 2018 our medium and long term thesis on oil is unchanged. Again, implicit in these numbers is no impact from further erosion in Venezuela nor any impact from Iran and thus we are effectively embedding a 1.5MM Bbl/d safety cushion in our assumptions:
Source: Ninepoint Partners
Source: Ninepoint Partners
Source: Ninepoint Partners
The market’s focus should now turn to spare capacity. If one accounts for the difference between current production levels within OPEC+Russia versus their previous high going back 2.5 years the difference is an underproduction of 3.5MM Bbl/d. Adjusting this number for countries that while producing below their previous highs lack the ability to increase production due to political reasons (Venezuela, Iran, Nigeria, Libya) results in a real “effective latent production potential” of 1.7MM Bbl/d. As the action today will reduce this number by 0.6MM Bbl/d OPEC’s spare capacity will fall to 1.1MM Bbl/d = ~1% of global production. The last time effective spare capacity was this low coincided with the last oil price spike to $147/bbl. This is incredibly important, especially in the context of underinvestment in long lead (4-6 year) projects resulting in OPEC only have the ability to organically grow production by 0.1MM Bbl/d per year until 2023.
Oil has fallen from $72 to $65 over the past month due to uncertainty around today’s outcome. We would expect oil to over the next few days begin to recoup much of these losses. Over the same time frame the average Fund holding has fallen 15% from their recent highs and we would expect over the near-term as investors “gross up” their energy exposure much/all of these losses to be regained.
Oil remains in a multi-year bull market and we believe will hit $100/bbl in 2020. If you haven’t read our May Commentary in which we go through our thesis it is worth the 10-15 minutes. Click here to read. Using $80/bbl we see 106% upside in Fund holdings.
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Source: Bloomberg, Energy Intelligence
1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at May 31, 2018; e) 2004 annual returns are from 04/15/04 to 12/31/04. The index is 100% S&P/TSX Capped Energy TRI and is computed by Ninepoint Partners LP based on publicly available index information.
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