Bank of America Merrill Lynch research report titled, “Global Emerging Market Weekly: Get ready to play vol-leyball”

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Report Highlights:

Raising the OPEC meeting stakes

  • OPEC meeting newsflow confirms our view that Saudi Arabia’s energy policy is likely to become less aggressive given increased macro strains
  • Serious negotiations are likely underway, but challenges abound. Potential supply shocks increase the incentives to reaching an agreement to support oil prices.

Informal OPEC meeting gaining momentum but challenges abound

Newsflow surrounding the informal Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC major oil exporting countries on September 28 on the sidelines of the 26-28 September International Energy Forum (IEF) suggest serious ongoing negotiations, yet also highlight important challenges to reaching an accord. A flurry of shuttle diplomacy meetings has been taking place, according to local press. The session is reportedly primarily for consultation but could lead to a more formal meeting later on. However, Saudi-Iranian political tensions and the potential for return of previously disrupted or delayed output could add to the difficulty of reaching an agreement, particularly one that would have a meaningful impact on the market, in our view. That being said, given that potentially resurgent output would likely keep the market oversupplied well into 2017, it also likely increases the incentives, urgency and importance of reaching an agreement to put a firm floor under oil prices, in our view.

Less aggressive Saudi energy policy going forward

The recently signed Saudi-Russian joint oil market memorandum confirms our view that, given increased macro challenges, Saudi energy policy is likely to be less aggressive. This was suggested in our reading of the medium-term National Transformation Plan (NTP). To remain consistent with internal NTP macro targets and diversification goals, we have estimated that oil prices have to average at least US$50/bbl in 2016-20. The Saudi-Russian agreement signals rapprochement between Saudi Arabia and Russia on energy policy with a view towards market stability, in our view. This is important because historically Saudi Arabia’s leadership position has meant its actions eventually extended to cooperation with OPEC and non-OPEC, and a few past multilateral agreements have been preceded by Saudi bilateral agreements. The press release also suggests that both countries view current oil market volatility as detrimental to energy markets as it could increase risks of medium-term supply shortages and disruptive boom-bust price cycles. It also suggests that they are likely to try to achieve a greater degree of stability in oil markets jointly or in cooperation with other oil producers.

Iranian existing oil ramp-up facilitates potential for accord, but Iran wants more

The possibility of an oil freeze at the IEF meeting depends on the treatment of Iranian oil production, in our view. Positively, the Iranian Oil Minister confirmed attendance at the IEF meetings, and there has been direct bilateral preparatory meetings between the Saudi and Iranian delegations. However, Iran continues to highlight its desire to regain market share and is suggesting that its model hydrocarbon contract could be finalised shortly, despite repeated delays, to help raise output from its current plateau.

Mixed Russian prospects

We note that Russian capacity to comply with any potential output freeze is limited by the large number of oil producing companies in the country. However, the incentives to deliver at least some effort to support the oil market are clearly there. Russia is now in the middle of the 2017-2019 budget cycle, where the government is intent on keeping a painful nominal spending freeze in order to keep the budget deficit within a 3% of GDP level, while at the same time it continues to deplete its fiscal reserves. This, we think, highlights tight budget constraints and strong incentives for the government to see oil

prices higher than the projected US$40/bbl.

Libyan oil market return complicates OPEC dynamics

Sustained Libyan oil output requires in our view at least 1) stable security; 2) approval by the international community; and, 3) allocation of appropriate funds to the National Oil Company (NOC). We think recent Libyan official pronouncements suggest order will be maintained, while the resumption of oil exports likely implies tacit approval by the international community as long as exports are conducted under the NOC banner. Last, higher oil proceeds will likely eventually create a self-funding virtuous cycle. While Libya’s return complicates OPEC dynamics, note that Libya did not attend the previous

OPEC and non-OPEC April Doha meeting. As such, we think it was likely never counted on in practice by Saudi Arabia and other countries to form part of a freeze agreement.

Nigeria positive supply shock to improve Fx liquidity

Any increase in Nigerian oil production, even if temporary, would provide it with a welcome inflow of dollars to Nigeria. Though the current ceasefire with the Niger Delta Avengers (NDA) has held for several weeks, the risks remain high. The NDA is not the only militant group operating in the area, and the current government may choose to prioritize development spending over the amnesty payments.

OPEC verbal rhetoric likely to remain supportive Saudi Arabia is likely to try to achieve at least positive rhetoric at the IEF meeting to provide a floor to oil prices, going into the weak seasonal period (due in part to refinery maintenance). The Saudi comments likely already helped pare back bearish speculative positioning. Given our view of tightening oil supply-demand balances next year, positive rhetoric that keeps prospects of a deal alive may be sufficient for Saudi for now.

OPEC verbal rhetoric likely to remain supportive

Saudi Arabia is likely to try to achieve at least positive rhetoric at the IEF meeting to provide a floor to oil prices, going into the weak seasonal period (due in part to refinery maintenance). The Saudi comments likely already helped pare back bearish speculative positioning. Given our view of tightening oil supply-demand balances next year, positive rhetoric that keeps prospects of a deal alive may be sufficient for Saudi for now.