On Sept. 22 OPEC and its allies announced that the agreement to cut production by 1.8 million barrels per day (bpd) was finally succeeding in rebalancing the market. Kuwaiti and Russian ministers, however, signalled that a decision on its extension was not imminent and it may not even be taken at November’s ministerial meeting.
If such a global effort is working well, then why would agreement on its extension be delayed until next year? Although there are many good reasons why producers should extend the deal, there are other factors that may either delay agreement about it or even prevent the extension full stop. Here are some of them.
1) The deal is working well. The market fundamentals are very strong at the moment thanks to the cuts agreement and other factors as well. The Joint Ministerial Monitoring Committee (JMMC) said in a statement that conformity levels of OPEC and participating non-OPEC producing countries in the deal was 116 percent in August, the highest level ever since the start of the deal in January. Notably, commercial oil inventories are falling remarkably in the second half of the year in the industrialized countries of the Organisation of Economic Cooperation and Development (OECD).
In August “the difference to the latest five-year average has been reduced by 168 million barrels since the beginning of this year,” JMMC said. The committee also saw better-than-expected oil demand in 2017 and a robust demand for next year. As a result, Brent oil prices have reflected all these factors and shifted from Contango into Backwardation, which might push oil stocks lower in coming months. With the agreement working well and fundamentals strong, some like Issam al-Marzooq, Kuwait’s oil minister, now think that more time is needed to evaluate the outcome of the deal and that the picture will not be clear until the first quarter of next year.
2) Not all Russian companies are on board. Russia is the world’s largest crude producer and is a big player in the deal; without its participation the deal might not have worked. Although Russia needs the agreement to push up oil prices and so enable it to balance its fiscal budget, it has internal issues with oil companies. Initially, there was a big resistance to the deal, but the decision was taken in the Kremlin and President Vladimir Putin has been supportive since the start.
So far it has benefited companies like Rosneft, the largest Russian oil producer. Next year, however, their views may change. Most Russian producers see a natural decline in production in the winter due to harsh cold weather in fields in Siberia. They will therefore be able to survive another winter, but as demand picks up, starting from the second quarter of 2018, they might be encouraged to call for an exit from the deal.
Alexander Novak, Russia’s oil minister, sent a clear message in an interview with Bloomberg TV on Sept. 22 that producers must consider an exit strategy and the exit should happen when demand is strong, presumably in the second or fourth quarters of next year.
This illustrates that Russia is not fully on board with the extension through 2018. This makes waiting until January seem sensible, with the hope that an extension will not be needed.
3) Producers have plans to expand production. Some countries are marching ahead with plans to boost output. Iraq plans to hit 5 million bpd of capacity by next year. The likelihood of Iraq sticking to this plan is increasing now that the Kurdistan region wants to split, which will leave Iraq with a smaller production capacity.
Kazakhstan is ramping up production from its long-delayed giant Kashagan field. Keeping an idle capacity is always expensive over a long period and many states would love to gain extra income from new increments.
Asking them to keep production low for all of 2018 will be a challenge, as many of those with expansion plans are already struggling to reach 100 percent conformity eight months on from the start of the deal.
4) Last but not least, shale oil may come back. Nothing is worrying OPEC and Russia more than shale oil producers. After two years of low prices, US drillers surprised the market with their resilience to a lower oil environment. But no one knows the extent of their ability to increase production when prices move upward.
Some believe that they are reaching a peak and this is why OPEC and Russia need more time to see how much shale oil producers can add with current oil prices at near $60. So it makes sense to wait until the shale oil picture is clearer before deciding what to do next.
The same applies for Libya and Nigeria who have been saying that they will not cap output until their production is stable and no one can tell for sure when will that happen.
The stakes for an extension are still high but the only surprise left is that OPEC and Russia could change the terms of the agreement and not its length.
• Wael Mahdi is an energy reporter specializing in OPEC and co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi