Does OPEC need an exit strat­egy?

Tehran Times - - ENERGY - (Source: oil­price.com)

One of the cru­cial de­tails that OPEC omit­ted when it rolled over its pro­duc­tion cuts for another year was how the group plans on wind­ing down the agree­ment. When pressed by re­porters, Saudi oil min­is­ter Khalid al-Falih said that it was “pre­ma­ture” to talk about an exit strat­egy.

Tak­ing “ex­tra­or­di­nary mea­sures” to res­cue the oil mar­ket with­out any idea on how to exit the in­ter­ven­tion is not un­like what cen­tral banks have done over the past decade to juice the global econ­omy. In­ter­ven­ing is easy, back­ing out is the tricky part.

Al-Falih em­pha­sized that any exit would be “grad­ual,” and he went to great lengths to point out the strong re­la­tion­ship be­tween Saudi Ara­bia and Rus­sia, and not ad­dress­ing how to end the deal is crit­i­cal to that. “For now, the OPEC-Rus­sia bro­mance con­tin­ues.” Jamie Web­ster, an OPEC watcher at the Bos­ton Con­sult­ing Group, told Bloomberg.

How­ever, if it took some arm twist­ing to keep Rus­sia on board for an ex­ten­sion this time around, it will be ex­ceed­ingly dif­fi­cult to ex­tend again in a year, when the oil mar­ket is much tighter. As of now, OPEC and Rus­sia don’t see global in­ven­to­ries fall­ing back into the five-year av­er­age un­til the sec­ond half of 2018—sea­son­ally lower de­mand dur­ing win­ter months sug­gests that the de­stock­ing process will take a breather in the first quar­ter.

In­cluded in the Novem­ber 30 an­nounce­ment was the fact that all par­ties would re­visit the agree­ment at the next OPEC meet­ing in June. That seems to be a for­mal­ity since the meet­ings are al­ways a time and place at which OPEC as­sesses the health of the oil mar­ket, but if the mar­ket tight­ens too much and prices rise sig­nif­i­cantly, Rus­sia could push to end the agree­ment early.

The flip side is that higher prices could spark another wave of shale drilling, which could keep a lid on prices and ex­tend the “re­bal­anc­ing” pe­riod. We’ll just have to wait and see, and the oil mar­ket will be left in the dark on the exit strat­egy un­til June at least, un­less some­thing ex­tra­or­di­nary hap­pens be­fore then.

Gold­man Sachs took a unique per­spec­tive, ar­gu­ing that OPEC made it clear that it would act to sti­fle volatil­ity, and that the oil mar­kets are un­der­ap­pre­ci­at­ing that fact. Ac­cord­ing to this view, the exit strat­egy is some­what of a mis­placed ques­tion.

Al-Falih’s com­ments about how the group will re­main “ag­ile and re­spon­sive” to mar­ket con­di­tions, com­bined with the fact that the over­ar­ch­ing ob­jec­tive of the pro­duc­tion cuts is to bring global in­ven­to­ries back down to the five-year av­er­age, in­di­cates that OPEC will “re­main data de­pen­dent, which re­duces the risk of both un­ex­pected sup­ply sur­prises and ex­cess stock draws,” Gold­man an­a­lysts wrote in a Novem­ber 30 re­search note.

“This leads us to re­it­er­ate our view that long-dated im­plied volatil­ity re­mains too rich in the face of grow­ing cer­tainty on breakevens and sources of fu­ture sup­ply,” Gold­man said. “Al­though an ex­act exit strat­egy was not for­mal­ized, to­day’s an­nounce­ment will fur­ther defuse long-term sup­ply un­cer­tainty in our view, with the lat­est earn­ings from U.S. E&Ps and oil ma­jors also con­firm­ing per­sis­tent de­clines in breakevens.”

In other words: Nervy oil traders won­der­ing about an exit strat­egy should just chill out—OPEC has ev­ery­thing un­der con­trol.

If the cuts tighten the mar­ket too much, OPEC has spare ca­pac­ity sit­ting on the side­lines that it can call into ac­tion, while the ex­ten­sion of the cuts should take care of any shale come­back. There is “time to set­tle” the com­ing growth in shale out­put “un­til the cuts end,” while the OPEC ex­ten­sion is still not too ag­gres­sive, Gold­man ar­gued, “re­in­forc­ing its volatil­ity damp­en­ing ef­fect.”

Mean­while, the cap on Nige­ria and Libya at 2017 pro­duc­tion lev­els takes away any sup­ply sur­prise from them.

In short, the oil mar­ket is in good hands; and the volatile trad­ing is un­jus­ti­fied.

Gold­man even said that it as­sumes that sim­i­lar pro­duc­tion cut agree­ments (if not this one) will “con­tinue in the com­ing years even af­ter pro­duc­tion starts to rise, con­sis­tent with OPEC’s modus operandi of the 1990s.”

Saudi oil min­is­ter Khalid al-Falih (R) and Rus­sian En­ergy Min­is­ter Alexan­der Novak at­tend­ing 173th OPEC meet­ing in Vi­enna on Novem­ber 30.

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