Continued US oil production cut is the key

The meeting of oil producers on April 17th in Doha ended without any agreement to freeze oil production in the near term.

In any case, as OPEC and Russian oil production already stands at record levels, any agreement would not have damaged those countries’ market share or altered forecasts significantly. Iran did not attend the meeting as it has just started to rebuild its production after years of international sanctions that were lifted only last January. Iran’s objective is to renew with past levels of production, increasing its output by 500kb/d by end-2017. It is therefore unlikely to agree to freeze output for quite some time yet.

The 3-day disruption (production cut by two-thirds, to 1.1Mb/d) caused by a workers’ strike in Kuwait has supported prices after the discord in Doha. This strike against cuts in wages and benefits to offset the lack of revenues is a reminder that oil-producing countries in the Middle East are facing significant budget turbulences and cannot compensate the lack of revenues forever.

However, US oil production is declining and, if the current trend is maintained over the next 6 months, it will be sufficient to reequilibrate the market. US production has been cut by 630kb/d and is expected to fall to 8.5Mb/d in Q3 2016, the equivalent of an additional 500kb/d cut. This was the US output in mid-2014 and is a realistic assumption, given the high number of rigs closed. Further, in Latin America, production should also continue to fall as production investments and entities have been cut.

While global supply has started to decline, the demand for oil is increasing. 2016 estimates show an increase of above 1Mb/d. Chinese slowdown fears have diminished and demand from India has recently accelerated by 300kb/d. Along with the cut in US production, the imbalances should disappear in Q3 2016 and the oil price should stabilize around current levels until Saudi Arabia decides to change its mind. In this context, we are keeping overweight exposures to high-yield bonds, emerging-market equities and commodity-sensitive currencies.