Saudi Arabia’s OPEC decision to make or break oil price

Thursday brings the most-watched meeting of the Organisation of Petroleum Exporting Countries (OPEC) in years, and it all hinges on what Saudi Arabia decides to do.

Market reaction is likely to be muted initially, as US traders will be absent because the meeting coincides with the Thanksgiving holiday.

The US is a big factor for any OPEC decision, as its dependence on imported oil has decreased dramatically because of the discovery and exploitation of shale oil in recent years.

This in turn has depressed oil prices and will almost certainly lead OPEC to cut production in an attempt to reduce supply.

Oil price and Saudi Arabia's OPEC decision

The oil price has fallen rapidly. It depends on Saudi Arabia’s OPEC decision. Source: Societe Generale

The question is, how much will OPEC manage to cut production? And consequently, what will a barrel of oil cost in the New Year?

Analysts at Societe Generale have two scenarios. In their most likely scenario, the base case one, they attach a 60% probability of an oil production cut of between 1.0 million barrels per day and 1.5 mbd following Thursday’s OPEC meeting.

Under this scenario, the cut would be initiated by the Saudis and would be shared by most OPEC members; individual country quotas would be part of the agreement.

This would bring the price of international crude oil, Brent, at $90 a barrel while West Texas Intermediate (WTI) would be up at $82 in 2015.

Their second scenario is a bearish one, in which Saudi Arabia does not operate any cut in production and instead allows the market, via price cuts, to readjust supply and demand, as some Saudi officials said they would in late September-early October.

This scenario has a 40% probability in their opinion and would mean Brent falls to $70 next year and WTI to $65.

Brent currently trades at around $80 and WTI is at a little more than $76 a barrel.

Among the hawks, the most vocal (and the most influential) OPEC members are Iran and Venezuela, and investors will be keeping an eye on them.

“Both have been participating in the recent rounds of oil diplomacy, but Venezuela has been especially active. Venezuela is, at this point, the only country to say that not only does it want OPEC to cut, it will cut its own production,” the Societe Generale analysts said.

Other countries, especially Iran, want Saudi Arabia to do most of the cutting.

The chances are that, if an agreement does not include country quotas, it will not be taken seriously by the market and the price of oil will not be significantly influenced.

But the lower the price drops now, the stronger the long-term rebound will be. Perhaps this is an alternative strategy that Saudi Arabia could be contemplating.

By allowing the Brent price to fall, the Saudis would be willing to help oil demand grow in their customers in Asia, which would be “fairly bullish” longer term, the Societe Generale analysts note.

Capital costs for oil are “materially higher” than the $70 per barrel to which a non-cut in the OPEC meeting would push the price.

At $70 a barrel, “investment would drop, legacy field decline rates would accelerate, and GDP and oil demand growth would be supported – preconditions for a stronger price rebound in due course,” the analysts noted.

Of course, there will be a lot of pain for oil producers in the meanwhile. Already, the 30% drop in price since June has caused a correction of about 22% in the European oil sector.

@AntoniaOprita

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