It was a relatively quiet week for analyst updates -- ExxonMobil XOM was tagged in the analyst note below from Morningstar Research Services about OPEC+ production cuts.
Best wishes,
David Harrell,
Editor, Morningstar StockInvestor
OPEC+ Defends Oil Prices With New Production Cut While Consolidating Influence Around the Saudis
by Stephen Ellis | Morningstar Research Services LLC | 6-06-23
On June 4, OPEC+ announced about 1.4 million barrels per day of production cuts. Saudi Arabia would cut 1 million barrels per day production cut in July 2023 for one month, though it can be extended, which we consider a realistic cut, while the remaining 400,000 net barrels are aligning quotas to actual production levels, and we'd consider paper barrels. The previously announced 1.6 million barrels per day cut (or about 600,000-700,000 barrels per day allowing for quota underproduction) by OPEC cut in April has now been extended through the end of 2024 from through the end of 2023. Our fair value estimates and moat ratings for our U.S. oil and gas coverage are unchanged following the announcement. We'd flag Equitrans and ExxonMobil as undervalued.
With the earlier cuts only beginning in May and having a limited impact so far, we see the latest announcement more about defending oil prices with the threat of further production cut extensions. Brent prices have fallen about 10% since the start of April to about $76 a barrel currently. At the time, we felt, as likely OPEC+ did, that the cuts would be enough to support higher oil prices in the near term with a potential spike to $100 a barrel remaining a possibility in the second half of the year.
Thus, the decline in price has likely frustrated the Saudis. Comments from Saudi Arabia ahead of the meeting have been unusually pointed and focused heavily on prices and oil short sellers, indicating in our view, the country is under growing pressure to keep prices high (above $80 a barrel) to ensure enough revenue to fund planned social spending over the next few years. Essentially, the cut and extension threats are widening the gap further in what we already saw as an undersupplied oil market in the second half of 2023 from our April observations. OPEC+ is also somewhat emboldened to cut production knowing that U.S. producers are not likely to steal share.
We see several key takeaways:
In a move that demonstrates Saudi Arabia's growing consolidation of influence within the cartel, several OPEC members including Angola, Congo, Nigeria, and Guinea had their baseline quotas reduced by a total of about 625,000 barrels per day. All four countries had been unable to meet their quotas for some time due to political, investment, or reservoir-related challenges. The reduced quotas more closely align actual production with quotas, meaning future production announcements will be more closely linked to actual production changes versus us having to interpret the level of shadow barrels. In contrast, the UAE's quota was upped about 200,000 barrels per day, more closely hewing to actual production levels.
Next, OPEC+ openly acknowledged the uncertainty over the amount of production that Russia is supplying the market presently. The OPEC+ quota is currently 9.828 million barrels per day. Russia has indicated at various times that it could cut production as low as 9.3 million barrels per day for varying timeframes. We see this uncertainty as linked to the Saudi cuts. The uncertainty over Russian production, and perhaps the reluctance of Russia to provide additional clarity or assurance around future production levels likely contributed the Saudi Arabia shouldering the burden of the 1 million barrels per day of production cuts alone. The Saudis called this their "Saudi lollipop" reflecting their confidence that they can achieve the announced cuts versus the April "voluntary" cuts outside of normal OPEC channels, and thus sending a strong positive price signal to the markets.
While we think the key takeaways here are primarily price, supply, and Saudi Arabian-focused, we note that concerns around the quality of the recovery for Chinese oil demand are lingering in the background. While the International Energy Agency acknowledged that it was upping its oil demand forecast in its May 2023 report, largely due to Chinese strength, with Chinese oil demand contributing nearly 60% of its expected 2.2 million barrels per day of demand growth in 2023. This revision places Chinese demand growth closer to 1.3 million barrels per day in 2023, compared with earlier expectations by the IEA, as we noted in April, which had demand growth of about 960,000 barrels per day. At the same time, we are seeing other indicators raise concerns about the maintainability of the growth, primarily around industrial activity. Some examples include a 13% decline in Chinese imports of copper through the first few months of 2023 per Capital Economics, an 8% decline in the number of trucks on Chinese highways through April 2023 per Ministry of Transport data, and a boost in Chinese
diesel inventory supplies toward eight-month highs according to OilChem.
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