BofA Equity Research's take on OPEC+ deal with UAE - July 15
Posted: Thu Jul 15, 2021 11:43 am
OPEC: UAE makes a deal
Over the last 48 hrs two issues have effectively bookended the outlook for oil markets.
The latest IEA report, published on 7/12 warned of the risks to a tighter oil market
should OPEC+ fail to resolve last week ’ s impasse. Then over the last 24 hours press
reports suggest Saudi and the UAE have agreed a compromise over the higher baseline
petitio ned by the UAE. If the headlines are to be believed the UAE will have its
production baseline increased from 3.168mm bpd to 3.65mm bpd, resetting the starting
point from which any future production agreement is determined, after April 2022. Of
course the d eal has to be ratified by the broader OPEC+ coalition.
However, as reviewed by BofA ’ s oil service team in its latest ‘ Chart of the week ’ report ,
we see the UAE circumstances as unique given a disproportionate level of investment to
expand capacity since 2015. The response from oil markets was a $2 drop in oil over the
course of the day. But beyond the headlines we don ’ t believe anything else has really
changed. A post -COVID demand recov ery remains our base case, while confirmation of a
compromise that secures an extension of the OPEC+ agreement means Saudi effectively
keeps control of oil markets, at least through end 2022.
Why has sector performance dislocated from spot prices?
The r esponse of the US E&P ’ s to the mid -$70 ’ s Brent price ceiling that has seemingly
been tested several times in recent weeks is another pull back in sector performance.
Feedback from investors has turned to questioning why with oil prices higher have
absolute and relative sector performance dislo cated. However, in our view this misses
one simple point that anchors our view of valuation for the US E&P ’ s: value is defined as
the discounted value of unlevered free cash flow , constrained only by inventory depth.
If that holds then it follows that volatility at the front of the oil curve i s a fraction of the
Enterprise V alue. If spot prices move up, but the long end of the curve is anchored within
a relatively tight range, sector performance will dislocate from spo t price s – with a
higher long term price the catalyst we believe will drive the next leg of sector
performance. The net is that the sector outlook remains entirely anchored on
expectations of demand recovery and continued intervention by OPEC+, which we
b elieve will be the outcome of a successfully brokered agreement between the UAE and
Saudi.
Over the last 48 hrs two issues have effectively bookended the outlook for oil markets.
The latest IEA report, published on 7/12 warned of the risks to a tighter oil market
should OPEC+ fail to resolve last week ’ s impasse. Then over the last 24 hours press
reports suggest Saudi and the UAE have agreed a compromise over the higher baseline
petitio ned by the UAE. If the headlines are to be believed the UAE will have its
production baseline increased from 3.168mm bpd to 3.65mm bpd, resetting the starting
point from which any future production agreement is determined, after April 2022. Of
course the d eal has to be ratified by the broader OPEC+ coalition.
However, as reviewed by BofA ’ s oil service team in its latest ‘ Chart of the week ’ report ,
we see the UAE circumstances as unique given a disproportionate level of investment to
expand capacity since 2015. The response from oil markets was a $2 drop in oil over the
course of the day. But beyond the headlines we don ’ t believe anything else has really
changed. A post -COVID demand recov ery remains our base case, while confirmation of a
compromise that secures an extension of the OPEC+ agreement means Saudi effectively
keeps control of oil markets, at least through end 2022.
Why has sector performance dislocated from spot prices?
The r esponse of the US E&P ’ s to the mid -$70 ’ s Brent price ceiling that has seemingly
been tested several times in recent weeks is another pull back in sector performance.
Feedback from investors has turned to questioning why with oil prices higher have
absolute and relative sector performance dislo cated. However, in our view this misses
one simple point that anchors our view of valuation for the US E&P ’ s: value is defined as
the discounted value of unlevered free cash flow , constrained only by inventory depth.
If that holds then it follows that volatility at the front of the oil curve i s a fraction of the
Enterprise V alue. If spot prices move up, but the long end of the curve is anchored within
a relatively tight range, sector performance will dislocate from spo t price s – with a
higher long term price the catalyst we believe will drive the next leg of sector
performance. The net is that the sector outlook remains entirely anchored on
expectations of demand recovery and continued intervention by OPEC+, which we
b elieve will be the outcome of a successfully brokered agreement between the UAE and
Saudi.