Why an extension of the OPEC oil deal matters


Why an extension of the OPEC oil deal matters

On Nov. 30, the oil ministers of the 14 members of the Organization of the Petroleum Exporting Countries (OPEC) meet to discuss the future of the deal with non-OPEC members to curb production, which is scheduled to expire at the end of March. 
The deal was first agreed last December, when producers agreed to reduce their crude oil output by a combined 1.8 million barrels per day. A rollover until the end of 2018 is under discussion and widely anticipated. Ministers will now need to weigh the pros and cons of curtailing production. 
A renewal of the deal looked certain in October, when both Russian President Vladimir Putin and Saudi Arabia’s Energy Minister Khalid Al-Falih sent strong signals in favor of an extension. However, Russian Oil Minister Alexander Novak recently wavered on the issue, as oil prices reached levels not seen since 2014. 
The fundamentals expected for next year may be less rosy than initially anticipated. Ministers will now have to weigh up whether they want to bank on fundamentals or pin their hopes on the geopolitical risk premium, which has added dollars to the price of oil during the last few weeks. 
Oil markets have been buoyant over the last three months. Brent rose from $45 a barrel in mid-July to $64 three weeks ago. Several forces were at play. A key factor was the drawing of crude stocks week after week, until they were at about 150 million barrels above the five-year average of Organisation for Economic Cooperation and Development (OECD) stocks, which is an important metric for traders. 
Both OPEC and the OECD watchdog, the International Energy Agency (IEA), agreed that the demand outlook was rosy for both 2017 and 2018, forecasting rises of 1.5 million barrels per day (bpd) and 1.4 million bpd respectively. Then there came the geopolitical premium on prices, due to factors such as the Iraqi army seizing oilfields in Kirkuk and the tenuous situation in Lebanon. Kim Jong Un’s shenanigans in North Korea and the potential default of Venezuelan debt underlined the geopolitical risks further.

Ministers will most probably err on the side of caution and renew the agreement.

Cornelia Meyer

The turning point came last week when IEA and OPEC oil-market reports put forward different demand forecasts. While OPEC increased its estimate for 2018 by 130,000 bpd, the IEA decreased it by 190,000 bpd. On top of that, the IEA forecast that the non-OPEC production increases expected for 2018 would pretty much even out any demand increases. 
No wonder traders felt it an opportune time to lock in some profits. Their combined long positions for Brent and WTI stood at around 1 billion barrels at the beginning of last week. They were selling and Brent was trading at around $63.11 bpd on Wednesday afternoon.
Ministers need to weigh up their assessment of the fundamentals against the outlook of the recovery. It is a judgment call. Ministers will most probably err on the side of caution and renew the agreement, especially as the IEA expects inventories to build in the first quarter of 2018 — as they usually do at the beginning of the calendar year. 
The recovery has mostly been sluggish over the duration of the deal to curb production, and it is still rather tenuous. Markets have more or less priced in a rollover. A failure to deliver would not bode well. Therefore the smart money is on Russia yielding, especially as their contribution to the agreement is a mere 300 barrels per day, which is negligible on the 11 million barrels they produce every day. Novak stands to gain a firmer the oil price — as do the OPEC nations.
• Cornelia Meyer is a business consultant, macroeconomist and energy expert. She can be reached on Twitter @MeyerResources.
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