When will the oil market rebalance? The answer to this question much depends on when the current production-cuts agreement between the Organization of the Petroleum Exporting Countries (OPEC) and other producers from outside the group finally ends.
Two ministers have given two different views on the rebalancing, illustrating the wide range of opinions in the market.
The Russian Energy Minister Alexander Novak said that he expects the market to rebalance in the first quarter of 2018.
On the other hand, Kuwait’s Oil Minister Issam Al-Marzooq told a local newspaper that he expects to see the market rebalancing by the end of the year due to higher-than-expected drawdowns in global oil stockpiles and the expected increase in demand in the third quarter.
The numbers from OPEC so far support Al-Marzooq’s view. Mohammed Barkindo, the secretary general of the organization, said on Sept. 11 that oil stocks in industrialized countries that are members of the Organization for Economic Cooperation and Development (OECD) have fallen by 145 million barrels since January.
The whole goal of the deal between OPEC and other producers — including Russia — is to bring down the stocks to the five-year average by removing 1.8 million barrels a day of global supply.
Those efforts are well underway, noted Barkindo. Assuming a further reduction in August and September, the OECD stocks might be at 110 to 120 million barrels. Another factor that will help in that regard is the forecast increase in demand in the second half of the year.
Despite all the encouraging numbers, there are risks to the deal that can prolong it. First, time is running out for OPEC, with only three months left until the end of the year and compliance with pledged cuts not yet at 100 percent. The compliance rate is improving and it might reach 98 percent for OPEC in August.
Without full compliance, or even higher-than-required compliance, it may not be possible for OPEC to bring down the stocks in the first quarter of next year. The reason for this is simple. Demand in the first quarter is always sluggish, as this is the time of the year when many refineries in the Northern Hemisphere go into maintenance season.
Second, current oil prices of around $53-$54 is good for state budgets but may not lead to a desirable outcome for the oil market. This price awakens the shale oil drillers who can offset any effort of OPEC by pumping more oil to the market. The Royal Bank of Canada describes this price range as a “gift for under-hedged producers” to “reset the clock on hedges for 2018.”
Shale oil producers rely on hedging. They lock in future prices today to allow them to keep drilling even if oil prices go do next year. The more OPEC prolongs the cuts deal, the more shale oil producers can sustain output. However, some suggest that shale capacity will not be as big as everyone expects and that we need to wait until next year to find out.
The last risk is from OPEC itself. Libya and Nigeria are exempted from the deal and they are free to increase production as much as they can.
Looking at the data, one could argue that Al-Marzooq is right and the market will rebalance sooner, meaning there will be no need for an extension of the cuts deal beyond the expiry of the deal in March. Looking at the contending risks, one can also argue that Novak might be right and that the market will only rebalance in the first quarter of next year.
If producers decide to extend the deal, they need to remember the reason why Andy Hall, one of the world’s most prominent oil traders, closed one of his funds in August. It was because OPEC’s extension suggested to him that the market will be weaker. This explains why almost all big banks revised down their oil-price outlooks. Any extension of the deal must be executed very well this time — and a possible exit from it crafted even more creatively.
• Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi