OPEC compromise deal fails to satisfy markets
We have come a long way since December 2016 when an alliance of OPEC and 10 non-OPEC countries — commonly known as OPEC+ — entered into an agreement to reduce their production by 1.8 million barrels of oil per day (bpd), with OPEC responsible for 1.2 million bpd worth of cuts. According to OPEC’s own numbers, the organization has gone beyond these commitments, with its compliance standing at 152 percent last month.
When the deal was struck, oil markets were massively oversupplied with prices less than half of the highs experienced in 2014. Fast forward 18 months however, prices have recovered somewhat and the overhang of inventories has all but gone, thanks to both the output cut agreement and rising global demand. But global oil markets are getting tight — very tight.
During its June 22 meeting OPEC reached a consensus to bring production in line with the agreement of cooperation, following several months of over-compliance that pushed prices up as high as $80 a barrel, but gave few details of how such a production rise would come about.
The outcome was a “deliberate ambiguity,” according to Helima Croft, RBC Capital Markets’ global head of commodity strategy, allowing OPEC to avoid the politically difficult subject of reallocating output quotas to its members.
OPEC and its allies need to remain vigilant though not just to the upside, but also to the downside.
Returning to 100 percent compliance with the OPEC+ deal — scheduled to begin next month — would result in about 700,000 additional barrels of production increases for OPEC, rising to around a million when incorporating production increases from its allies outside the bloc.
The lion’s share of the increase from OPEC will no doubt hail from Saudi Arabia (alongside contributions from Kuwait and the UAE), with Russia accounting for much of the additional barrels from the non-OPEC producers. This will no doubt please Igor Sechin, CEO of Russia’s largest oil company Rosneft, who has long advocated bringing some of his new built capacity on stream.
OPEC had hoped for markets to ease and the oil price to fall. But there was not nearly enough clarity for markets as to how many more barrels would be released and where they would come from, with Brent crude surging 3 percent after the announcement leaked out. In hindsight, markets might also have been influenced by Saudi Arabia and Russia having also talked up market shortages in order to get wayward countries in line with their quest to increase production. Whereas this clearly bore fruit internally, it also resulted in markets expecting a stronger outcome of the meeting.
The run up to Friday’s meeting was turbulent to say the least, with Iran,Venezuela and Iraq opposing any production increases. Venezuela has been among the main culprits in terms of reducing production beyond what was agreed, with its oil industry in freefall over the past 18 months due to the country’s dire economic situation.
Iraq had done well under the OPEC+ agreement and was able to increase its relative standing in OPEC, even replacing Saudi Arabia as the biggest supplier to India. But Iraq has no production headroom left and fears for its new found relative position. Iran meanwhile fears that it will lose exports in excess of 400,000 bpd once US sanctions kick in later this year.
Uncertainty over a deal eased markedly when Saudi Arabia’s Energy Minister, Khalid Al-Falih assured the world that OPEC would listen to all the views of its member countries during its Thursday seminar. The “deliberate ambiguity” over quotas and allocations was therefore the price of Friday’s agreement. OPEC decisions need to be unanimous, and this was the best the organization could do under current circumstances.
At Saturday's press conference, which confirmed that Russia and other non-OPEC nations would also adhere to the 100 compliance agreement, Al-Falih made it very clear that KSA was poised to up its production to the extent needed while being respectful of maintaining a balance amongst the various member countries. He added that the first responsibility of the alliance was to remain responsive to the market.
But markets don’t tend to care about such internal politics, and seek clarity above all else. Added to that is demand, which grew by a stunning 1.5 million bpd in 2017 and is expected to grow between 1.3 and 1.65 million bpd this year.
OPEC and its allies need to remain vigilant though not just to the upside, but also to the downside. Growing disputes between the US and trading partners like China and the EU could seriously dent economic growth, resulting in the localization of supply chains and lower cross border trade, negatively impacting oil consumption. Further US interest rate hikes might also adversely affect economic growth in emerging markets, which is after all where the bulk of the demand growth takes place.
Therefore Khalid Al-Falih is on to something when he insists that the agreement of co-operation needs to be institutionalized. There needs to be a quick reaction mechanism to deal with the vagaries of the markets. Currently there are not enough barrels to go around and more production is needed. But this could look very different soon, if President Trump’s trade war intensifies.
- Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources