Thrills but no spills at oil meeting
Markets reacted well. Brent now trades comfortably above the $63 mark. Saudi Arabia and Russia took firm control of the process. They will now co-chair the Joint Ministerial Monitoring Committee (JMMC), which is in charge of ensuring the deal remains on track and that participants are in compliance. Saudi Arabia and Russia together produce in excess of 20 million barrels per day (bpd), which constitutes more than 20 percent of global production.
The outcome of the meeting in Vienna was a big success for the diplomatic skills of Saudi Energy Minister Khalid Al-Falih and OPEC Secretary-General Mohammed Sanusi Barkindo. They were able to get 24 countries to agree on quantity and time. However, the run-up to the meeting was not without drama: There were rumors that Russia may not be on board with the deal, which temporarily sent the oil price tumbling.
At the outset of the meeting Al-Falih was therefore clear that an extension of the deal and compliance were crucial to bring the historic overhang of global crude inventories down. The OECD inventories are now around 140 million barrels above the rolling five-year average, which is about 60 percent lower from where they were a year ago. Al-Falih pointed out time and again that the deal was starting to achieve its aim, but that there was further to go. He is right: The futures market is around 1 billion barrels long. Any disappointment in market sentiment could well lead to profit-taking and a major sell-off.
The deal to keep down production is done for the time being but there are still risks for the market.
Both Russia and Saudi Arabia stand to gain from a higher oil price: Saudi Arabia is reorganizing its economy in accordance with Saudi Vision 2030, which is expensive and includes an IPO of the state-run oil giant Saudi Aramco. The cost of the cuts is minimal for Russia, because the country only signed up to 300,000 bpd of cuts on a production exceeding 11 million bpd. The Russian economy can well use the infusion of cash resulting from higher oil prices: There are still sanctions hanging over the country and President Vladimir Putin faces an election in March of next year.
The deal is done for the time being. However, there are still risks facing the oil market. On the downside, it is unclear how much incremental shale production will come on stream due to higher oil prices. US shale production is forecast to reach 6.17 million bpd in December. The International Energy Agency is concerned that increases in US shale — and other non-OPEC production — might dent the effect of the production cuts. There is also the question of when and how to unwind the deal, which is similar to what central banks face when they try to exit expansive monetary policies. To that end Russia’s Energy Minister Alexander Novak, on the margins of the meeting, mentioned that he was not in favor of an unlimited duration of the deal.
On the upside, the global economy is in the best shape since 2008, which is good news for demand. The future of Venezuela’s production hangs in the balance as the country faces internal turmoil. There are always possible unforeseen outages in OPEC and non-OPEC countries. The gradual rebalancing of the market has also brought back the political risk premium, which means that tensions in the Middle East and elsewhere may well exert an upward pressure on the price. Lastly we should not forget that the prolonged period of low oil prices resulted in the cancelation of up to 40 percent of scheduled investment of international oil companies over the past few years. This is certainly on the mind of Al-Falih. So much so, that he specifically stressed this risk during the press conference.
Extending the deal has borne fruit for the time being. Markets are rebalancing and prices are rising. As always, there are upside risks and downside risks to the oil price. There is no time for complacency and both OPEC and non-OPEC signatories to the deal will need to monitor the situation closely and fine-tune actions and messaging on a continuing basis.
• Cornelia Meyer is a business consultant, macroeconomist and energy expert.
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