Contrary to expectations, OPEC managed to reach an agreement at the sidelines of the Global Energy Forum held in Algiers. But it's too early to say this will be turning for the oil market.

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2. Special Report | October 20162
Against this backdrop, it is worth asking whether this move represents a definitive departure
from Saudi Arabia’s – and by extension OPEC’s – strategy over the past two years or so of
flooding the market with oil, with a view to capturing market share and using low oil prices to
drive out the high-cost shale producers. Whether this is indeed the case, remains to be seen,
but the point to reiterate here is that persistently low prices have wreaked havoc on Saudi
public finances, such that it has had to commit itself to a rigorous austerity programme,
including subsidy reforms and cuts to public sector pay, which are staring to bite and could
over time raise the ire of the local population. Beyond Saudi Arabia, the fact that other OPEC
members, such as Venezuela and Iraq, are also burdened by low oil prices, made it somewhat
easier to sell this policy change to them, though concessions had to be made to the likes of
Iran and Libya to enable them to return to more normalised level of production which they
enjoyed in the past1
(see below).
…A move welcomed by the markets…
While the OPEC meeting was much anticipated, markets were not hopeful of any agreement
being reached – let alone one which entailed production cuts. In the event, the fact that a deal
was reached wrong-footed the market, with the result that it caused Brent crude prices to spike
over 7% – just shy of the US$50/b mark – within the initial two days that the deal was
announced. Although Brent prices have risen further since – at one point toping US$52/b –
underlying uncertainty and, as result, volatility remains high, in part thanks to the markets
questioning the ability of OPEC to deliver on these cuts. Additionally, it is also worth noting
here that since the start of 2016 oil prices have struggled to break out of the ~US$30-50/b
range (see Chart 3), a band which in our mind needs to be more decisively broken on the
upside in order to provide a more convincing signal that prices are on an upward trajectory.
1
Following the imposition of international sanctions on Iran relating to its nuclear programme, its oil production
roughly halved from over 4m b/d. Libya, meanwhile, has seen its oil output severely disrupted due to civil strife
and an ongoing war among opposing factions in the country.
0 2 4 6 8 10 12 14
Saudi
Arabia
Iraq
Iran
UAE
Kuwait
Venezuela
Angola
Nigeria
Algeria
August
Potential
(Source) OPEC
Chart 1: Saudi Arabia has been Producing
Oil Close to Full Capacity
(Oil production, million barrels/day)
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Saudi fiscal balance (LHS)
Brent crude (RHS)
Chart 2: Falling Oil Prices have Wreaked
Havoc on its Fiscal Position
(US$/barrel)(% of GDP)
(Source) Macrobond
(Year)

3. Special Report | October 20163
Separately, it’s also worth noting here that since the announcement of OPEC’s deal in Algiers
late last month, not only have oil prices received a leg-up but, over and above this, the equity
prices of companies involved in the oil and gas sector have also enjoyed fillip (see Chart 4).
While we take some comfort from this development, it is worth highlighting that some of the
rally seen in the share price of these companies may have been exaggerated somewhat by
investors reversing some of the short position that they had amassed against such companies
in light of the recent rally in oil prices.
…But we doubt whether the agreement will fundamentally alter the
prospects of the oil market at least in the near-term
Although we were pleasantly surprised by the ability of OPEC members to put aside their
differences and come to an agreement to cap their oil production, we remain sceptical about
how much any agreement is going to change the dynamics in the oil market, at least in the
near-term. Indeed, if anything, we feel that the recent price increases that we have seen could
turn out to be a “buy on the rumours, sell on the facts” events. This, in our mind, is likely to be
supported by the following factors:
 First up, the agreed level of output at 32.5-33.0m b/d – which amounts to cuts of 240k b/d
to 740k b/d is not that ambitious – especially when compared to OPEC’s initial output cut of
1.5m b/d in 2008. Additionally, even the lower of those of two targets (32.5m b/d) is roughly
about what they were pumping between last November until the early months of this year
(see Chart 5). During that time the monthly average price for Brent crude came in at slightly
above US$40/b. So, it could be that the move – if they can accomplish it – does nothing
material to push prices out of the current range, whereby they have fluctuated between the
mid-to-late 40s level. Separately, also of note here is the fact that Saudi production has
been at record highs over the summer, at around 10.7m b/d, and was set to fall somewhat
anyway due to seasonality, making the “cut” more of a “freeze” at record levels.
0
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60
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10 11 12 13 14 15 16
(Brent crude, US$/barrel)
Chart 3: Oil Prices Appear to have Stabilised but
Continue to Remain Range-Bound for the Time Being
(Source) Macrobond
(Year)
Oilpriceshavebeenrange-bound
withintheUS$30-50/dayband
92
94
96
98
100
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106
Jul 16 Aug 16 Sep 16 Oct 16
MSCI world Index
MSCI oil and gas sector
Chart 4: The Equity Performance of Oil and Gas-
Related Companies have Gone from Underperforming
to Outperforming the Wider Market
(Source) Macrobond
(Price return, 01/07/2016 =100)

4. Special Report | October 20164
 Second, Iran was exempted from the deal as were Libya and Nigeria. Iranian oil has
increased to around 3.6m b/d since the lifting of sanctions but the country wants to reach its
pre-sanction level, which stood at slightly over 4m b/d, implying that the country will likely
be inclined to pump at least another 0.4m b/d, a figure which will go some way to offset any
productions cuts by OPEC. Aside from Iran, Nigeria production is recovering after being
plagued by sabotages and reached 1.5m b/d in August, still below last year’s level of 1.8m
b/d. Libya, meanwhile, continues to struggle with civil strife and its production fell below
0.3m b/d in August as a peace agreement there has failed to restore security. While the
lack of investment and infrastructure makes a return to pre-war level of 1.7m b/d impossible
in the near-term, production could double quickly if there were to be any durable cessation
of hostilities between the warring parties in the country.
 Third, beyond the OPEC countries, it appears that some of the other major oil producing
nations, such as Russia, are regaining their production poise with the most recent
estimates for the country suggesting that it pumped at, or near, record highs of around 11m
b/d as new production facilities came online. Elsewhere, and perhaps more importantly, in
the US, the drop in overall US production already appears to have plateaued at around
8.5m b/d and, reflecting this, there’s been a noticeable uptick in the rig count since this
spring (see Chart 6). We expect any upward drift in prices as result of the OPEC agreement
to further incentivise shale producers to re-enter the oil market, helped in part by the fact
they have increasingly become more efficient/cost-effective in running their operations
recently. Indeed, in the early days of the shale boom, break-even costs of around
US$100/b were pretty common in the shale space, but more recent analysis by the likes of
Wood Mackenzie suggests that some shale regions, such as Wolfcamp, can break-even
with oil prices as low as US$40/b.
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Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16
OPEC production (LHS)
Brent price (inverted, RHS)
Chart 5: OPEC Output vs. Brent Price
(Million barrels/day) (US$/barrel)
(Source) Macrobond

5. Special Report | October 20165
 Finally, on the demand side, given the litany of headwinds facing the global economy,
including China, we are rather cautious about the prospect for the world economy for both
this year and next and do not envision growth rising much above the 3% or so mark, a
figure which will somewhat lag the average of around 3.5% seen over the past five years.
As such, we do not see oil demand growth rates rising much in excess of the levels that
have been evident over the last couple of years, a factor which, all other things being equal,
will likely cap oil prices going forward.
Against this backdrop, our overall sense is that the current excess supply on the global oil
markets – estimated to be in the region of around 0.5m b/d – is set to persist for a while yet.
While the likes of the IEA have been predicting, at least until recently, that the global oil market
would regain its balance towards the end of this year, our view is that this threshold will more
likely be achieved during the first half of next year, not least because OPEC’s proposed
production cuts will take some time to gain traction, while global oil demand will remain rather
sluggish for the time being.
Taking stock/concluding remarks
With the recent collapse in global oil prices starting to hurt even the lowest cost oil producers
among OPEC, it was only a question of time before the cartel relented on its policy of
producing flat out, with a view to weeding out the high cost producers, namely the shale plays
in the US. While the rise in oil prices which has accompanied the announcement of this policy
shift, appears to suggest that OPEC may have been vindicated in changing direction, we’re of
the view that this should not be seen as a game changer for the global oil market, at least in
the near-term, especially in the event that there is no buy-in for the deal among the non-OPEC
countries. Additionally, the OPEC accord should not, in our mind, necessarily be interpreted as
a comeback of OPEC as the world’s “swing producer”. For one thing, the advent of shale
means that any rise in oil prices as result of OPEC production cutbacks will likely be
accompanied by an increase in oil production on the part of shale companies. Additionally,
given the fact that the agreement reached in Algiers amounted to an “agreement in principle”,
the actual process of bedding down this agreement, in terms of finer details, still needs to take
place. With this in mind, there is a risk that the agreement could still unravel at the final hurdle.
Finally, it’s also worth mentioning that even in the heyday of OPEC in the 1970s and 80s
7.5
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Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16
Rig count (LHS)
US oil Production (RHS)
(Source) Macrobond
Chart 6: US Oil Production Could be at an Inflection Point if the
Rig Count Continues to Rise
(Million barrels/day)(Number of rigs)

6. Special Report | October 20166
cheating among its member states on production quotas used to be a widespread practice and,
with the advent of shale, this is likely to only get worse as some member states will be very
reluctant to relinquish market share to such producers.
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