Opec activity and its impact on local markets

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Opec activity and its impact on local markets
The Opec decided to raise the ceiling of daily production from 30 mbd to 31.5 mbd in December 2015.

Published: Wed 13 Jul 2016, 8:40 PM

Last updated: Wed 13 Jul 2016, 10:47 PM

The sharp drop in the price of oil since June 2014 has turned the world's attention to the Organisation of the Petroleum Exporting Countries and its role in stabilising the oil market. Initial hopes that the Saudi Arabia-led Opec would come to the rescue and balance prices by curtailing its oil production were put to rest after the Opec decided to raise the ceiling of daily production from 30 million barrels per day (mbd) to 31.5 mbd in December 2015. The decision was based on the grounds that production cut by the Opec alone would not be enough to stabilise the oil market, hence there is a need for a collaborated effort between the Opec and non-Opec members to strengthen the oil market dynamics in the current environment.
Consequently, the Opec and non-Opec members, especially Saudi Arabia and Russia, the world's two largest oil producers, initiated a dialogue in January 2016 to freeze the output at current levels. However, hopes were shaken after a couple of Opec members, especially Iran and Iraq, objected to the decision to freeze output. As a result, the Doha talks failed with Saudi Arabia categorically stating that the country would be willing to freeze output only if all members would participate and adhere to the agreement.
More recently, the market's attention has shifted to the depleting storage inventory in Saudi Arabia and an unprecedented move by the UK to leave the EU. For the energy sector, the depleting inventory and falling exports from Saudi Arabia despite the near record production is an important development. The kingdom's oil inventories declined for the sixth consecutive month, the longest stretch over the past 15 years, to 290.9 million barrels at the end of April 2016, a two-year low. More importantly, the inventory drawdown is likely to continue for the foreseeable future which should rebalance the demand and supply and further support the oil prices going forward.
Britain's decision to leave the EU will impact oil consumption both in the UK and globally. However, it is unlikely to have a significant impact on demand as Britain is not a major consumer of oil, with its 1.6 million barrels per day representing just 1.6 per cent of global consumption. The EU, on the other hand, is a major oil consumer at around 11.1 million barrels per day, just behind China's demand. The concern for markets would be the possibility of a contagion, with other EU countries possibly following Britain and exit the group, which could lead to economic disruptions.
Buoyed by the possibility of an agreement between the Opec and non-Opec members, oil prices began to rally after touching a 12-year low of $27.9 (closing price) per barrel on January 20, 2016. Increasing demand from Asian refineries, coupled with declining US shale production and depleting storage capacity over the past few months are leading the markets towards convergence of demand and supply. As a result, oil prices increased by more than 80 per cent to touch $50 by mid-June 2016. However, the positive momentum in oil prices was cautiously followed by the global equity markets but not much by the regional equity markets as they fear oil prices to remain range-bound given the indecisiveness of the Opec meeting. An analysis of Brent prices vis-à-vis the GCC and global index during 2016 suggests a correlation coefficient of 0.55 and 0.87, respectively, indicating a strong uphill linear relationship.
Most importantly, the fallout in agreement between the Opec and non-Opec countries in April and June 2016 had limited impact on equities and oil prices as market participants were not expecting the deal to materialise on account of different agendas and vested interests of both the Opec and non-Opec members. As a matter of fact, markets would have been positively surprised if such a deal would have happened or even if the talks would have progressed further as it would have sent a positive signal that larger and prominent members were ready to forego their "market share over prices" policy.
Furthermore, the inventory drawdown in Saudi Arabia over the past six months helps in reducing the supply glut and improving the demand supply mismatch expected by the markets. On the other hand, regional governments have already adjusted to lower prices and are increasingly focusing towards economic diversification initiatives and the growth of the non-oil economy.
The writer is founder and CEO of Al Masah Capital. Views expressed are his own and do not reflect the newspaper's policy.

By Shailesh Dash

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