Citi: Prepare For An OPEC Disappointment

A week out from the OPEC meeting, everyone is assuming a rollover of the production cuts for an additional nine months will be a simple formality, putting the limits in place until the end of 2018. But what if such a scenario fails to materialize? What if the cuts are for a shorter duration, or perhaps worse, there is no consensus at all?

Russia is likely to be the key to this puzzle, and there are reports that Russian officials are not convinced that any action is needed at this time. They argue that it is too early to announce anything, and that the OPEC/non-OPEC alliance should just wait until the expiration of the current agreement (March 2018) draws closer.

That would not be a satisfactory outcome for the vast majority of oil speculators (or for other oil producers around the world), who have baked an extension into their assumptions. Record bullish bets expose the oil market to a steep selloff should OPEC and its non-OPEC partners falter.

“There is an exuberance in the market about there being a done deal to extend through the end of 2018 and I think there’s likely to be disappointment in that come Nov. 30,” Ed Morse, head of commodities research at Citigroup, told Bloomberg earlier this month. “Our base case is that we do not get a full-year extension on Nov. 30.”

Citi says it’s possible the group only extends through June 2018, which would line up with the next official OPEC meeting. Another possible scenario is simply waiting until January or February 2018 before making a decision on an extension, which sounds close to what some Russian officials are supporting. For what it’s worth, two months ago, Russia’s energy minister Alexander Novak said “that January is the earliest date when we can actually, credibly speak about the state of the market.”

Citi predicts that the production limits will eventually be extended through the end of 2018, but it will be done in a series of announcements rather than all at once next week.

If the group doesn’t extend through 2018 at the upcoming meeting, it is hard to see any other outcome than a sharp drop in oil prices. “There’s a short-term possibility of a selloff,” Citigroup’s Morse said.

But Citi isn’t alone. A few weeks ago there seemed to be a consensus among oil analysts that the extension was essentially a done deal. Citi voiced skepticism, but more recently others have come around to that position as well. Hesitation from Moscow seems to be eroding confidence in the prospect of an extension.

Last week, Macro-Advisory made a case for why Russia should balk at an extension. At first blush, rejecting an extension that causes a selloff in oil prices seems like a “crazy position to take,” but it might actually make “perfect sense,” according to Chris Weafer, senior partner at Macro-Advisory. That is because Russia can make money with oil prices in the mid-$50s, a price level that is satisfactory while also low enough to keep U.S. shale from roaring back. Anything in the $60-$65 per barrel range would make Russian support for an extension “very unlikely,” Weafer argued. Brent has been trading in that range since the beginning of November.

"The higher the price of oil then raises the risk of more investment into, for example, U.S. shale and Canadian Sands projects, which, as was seen in 2014, risks a big increase in global supply," Weafer said in a research note originally published in an article for The Moscow Times. Weafer argues that if Russia backed an extension, it could merely sow the seeds of another price downturn.

Citi echoed that, making the case that “the math is indicating Russia should let the OPEC+ agreement expire,” as higher production would make up for lower prices.

Weafer of Macro-Advisory also said rejecting an extension would help Russia diversify its economy away from oil, a long-term argument that may not carry a ton of weight as Russian officials head to Vienna next week. More important are fiscal balances in the near-term, as well as the Russian presidential election early next year. Nevertheless, balking at an extension would carry benefits to Russia, Weafer argues, much more so than for the OPEC countries.

"All of this compares a lot more favorably with the typical OPEC-country model and are powerful reasons why Moscow is today more comfortable with a sustainable price in the $50s than closer to the mid-$60s," he wrote.

With all of that said, these estimates and calculations calling for Russia to reject an extension come from a bunch of economists. If anything can be concluded from the actions of Vladimir Putin over the past few years, it is that simple economic calculations are not necessarily the top priority in the Kremlin. Russia has a growing geopolitical relationship with Saudi Arabia, as Bloomberg Gadfly notes, as well as increasing influence in the Middle East. These facts probably carry a lot more weight than the fiscal tradeoff between supporting or rejecting an extension of the OPEC deal.

In that context, as Putin looks to extend his reach into the Middle East, the odds are that Russia signs onto an extension.

By Nick Cunningham of