Why an extension of the OPEC deal matters

Why an extension of the OPEC deal matters

May 25 is getting closer. It is the date when the Organization of the Petroleum Exporting Countries (OPEC) will decide on whether it wants to adhere to the current production cuts agreed last November. Then OPEC agreed to reduce production by 1.2 million barrels per day (bpd).
Non-OPEC countries, led by Russia, agreed to take a further 600,000 bpd out of production. OPEC compliance was well above 90 percent owing to over-compliance by Saudi Arabia and Kuwait and the persuasive powers of OPEC Secretary-General Mohammed Sanusi Barkindo.
Since the deal, the oil price has hovered in the $50 to $55 range with spikes above and below. OPEC is slowly achieving its goal. But the production cuts failed to bite as speedily as was hoped for.
The dark horse was the US shale oil sector: No one knew how quickly shale production would be ramping up once prices were on the rise again.
Shale oil is relatively expensive to produce but the sector had become leaner, meaner and more efficient.

You could argue that oil markets would eventually balance with or without extended production cuts. However, markets are reactive by nature, prone to psychological influences and are largely events-driven.

Cornelia Meyer

Ownership structures had also changed: Many of the highly leveraged small shale producers went out of business when the oil price fell below $40.
Their properties were snapped up by established players such as Exxon and Chevron. Indeed, around one out of five barrels currently lifted by Exxon is shale oil.
The post-OPEC deal price scenario also brought more capital into the US shale oil space: During the first quarter of 2017 private equity funds alone invested $19.6 billion in the sector.
To extend or not to extend?
Earlier this month, Saudi Energy Minister Khalid Al-Falih confirmed that an extension of the agreement was likely.
The precise shape of any agreement — especially the non-OPEC participation — is still unknown. There has, however, been a series of behind-the-scenes negotiations among OPEC members as well as with their non-OPEC counterparts.
It is true that OPEC, the International Energy Agency (IEA) and the US Energy Information Administration (EIA) predict that oil markets will come into balance within the second or third quarter of 2017 and that the historically high oil inventories will then be reduced — gradually and over time.
It is also true that the IEA predicts global oil demand to grow by 1.3 million bpd in 2017, as opposed to a projected supply increase by a meager 485,000 bpd. This explains why several analysts foresee an oil-price hike to $65 by the end of the year.
You could argue that the markets would eventually reach a balance with or without an extension of the OPEC deal. However, markets are reactive by nature, prone to psychological influences and largely events-driven. This is why the deal matters.
A failure to renew the deal might send the oil price in a tailspin. OPEC ministers and oil producers are all too aware of these market idiosyncrasies, which is why Barkindo spends time communicating with and trying to understand Wall Street.

• Cornelia Meyer is a business consultant, macro-economist and energy expert. She can be reached on Twitter @MeyerResources

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