OPEC takes cen­ter-stage as mar­kets await out­put deal

NBK ECO­NOMIC RE­PORT

Kuwait Times - - BUSINESS -

More than a month af­ter OPEC’s sur­prise an­nounce­ment that it would con­tem­plate its first pro­duc­tion cut in 8 years and the oil mar­kets re­main gripped by a sense of ex­pec­ta­tion ahead of the group’s next meet­ing at the end of Novem­ber. Volatil­ity was in­deed lower in Oc­to­ber, but judg­ing by the de­cline in oil prices since the third week of the month, the omens do not look good that an agree­ment can be fi­nal­ized by the next OPEC meet­ing.

By the 31 Oc­to­ber, af­ter two con­sec­u­tive days of losses, Brent closed at $48.3 per bar­rel (bbl), down 1.5 per­cent since the start of the month. The re­ver­sal from Brent’s ear­lier gains in the month was stark. In­deed, dur­ing the first half of the month Brent was trad­ing in the $51-53/bbl range, at a 12-month high, buoyed by de­clines in US crude stocks and in OECD com­mer­cial crude in­ven­to­ries, be­fore its price dropped well below the $50 level. Sim­i­larly, West Texas In­ter­me­di­ate (WTI), the US marker, fell to $46.8 by Oc­to­ber’s close of play, hav­ing been as high $51.6 at one point dur­ing the month.

Fi­nan­cial strain

Op­ti­mism re­gard­ing a po­ten­tial OPEC deal to rein in sup­ply be­gan to fade af­ter Iraq an­nounced that it, too, should be ex­empt from oil pro­duc­tion cuts due to its on­go­ing con­flict with the so-called Is­lamic State (IS). Iraq in­sisted that the fi­nan­cial strain of the war pre­cluded a cut in pro­duc­tion and hence oil rev­enues. With OPEC’s sec­ond largest pro­ducer ex­pect­ing to join Iran, the group’s third largest pro­ducer, Libya and Nige­ria on the side­lines, it would be left once more to Saudi Ara­bia, OPEC’s largest pro­ducer, to shoul­der a dis­pro­por­tion­ately large share of the cuts, some­thing the king­dom has been re­luc­tant to do.

According to their 28 Septem­ber Al­giers com­mu­nique, OPEC is look­ing to bring its pro­duc­tion down from around 33.6 mil­lion bar­rels per day (mb/d) at present, according to In­ter­na­tional En­ergy Agency (IEA) es­ti­mates, to within a range of 32.5-33.0 mb/d. A cut of 0.6 to 1.1 mb/d would in­deed be suf­fi­cient, el­e­vated global crude stocks not­with­stand­ing, to bring the mar­ket to bal­ance given that, according to the IEA, the sur­plus of sup­ply over de­mand had nar­rowed to 0.3 mb/d in the last quar­ter from a high of 1.5 mb/d in 4Q15.

If Saudi Ara­bia and its Gulf al­lies pare back pro­duc­tion by the 4 per­cent they sug­gested at the re­cent tech­ni­cal con­fer­ence in Vi­enna, and this is ex­tended to the rest of OPEC ex­clud­ing Iran, Iraq, Nige­ria and Libya, then the mar­ket could plau­si­bly move even be­yond bal­ance and into a sup­ply deficit of -0.5 mb/d in 4Q16. This sce­nario as­sumes that ex­empt OPEC mem­bers, with the ex­cep­tion of Libya, max­i­mize pro­duc­tion to near sus­tain­able ca­pac­ity lim­its and non-OPEC coun­tries, such as Rus­sia, do not boost their own pro­duc­tion in the mean­time. Should no out­put cut agree­ment be forth­com­ing at the next OPEC min­is­te­rial meet­ing, then pro­duc­ers will likely con­tinue pump­ing at will to max­i­mize mar­ket share; with de­mand growth ex­pected to slow, to 0.3 mb/d in 4Q16, the sup­ply sur­plus could widen to 0.7 mb/d in the same quar­ter. Rebalancing would once more ex­tend into the sec­ond half of 2017 as the rate of stock draw­downs slows. The im­pact on oil prices would be ob­vi­ously neg­a­tive, as pro­duc­ers re­main locked in a metaphor­i­cal race to the bot­tom. In the ab­sence of con­sen­sus be­tween OPEC mem­bers re­gard­ing the mag­ni­tude, dis­tri­bu­tion and polic­ing of any pro­posed cuts, and the un­cer­tain par­tic­i­pa­tion of non-OPEC Rus­sia, all this re­mains hy­po­thet­i­cal, how­ever.

Mar­ket op­ti­mism was also tem­pered in the last few days by pro­duc­tion data in­di­cat­ing that not only is Nige­rian and Libyan sup­ply ramp­ing up af­ter a pro­longed pe­riod of out­ages, but that US out­put may also be re­cov­er­ing af­ter al­most a year and a half of be­ing un­der pres­sure. This would seem to be backed by in­creases in the num­ber of drilling rigs, in the US and, in­deed, world­wide, which is of­ten taken as a proxy for pro­duc­tion. The US has been steadily bring­ing rigs back on­line since May, when rig counts were down by 80 per­cent from their 2014-high at a low of 318.

While the data is pre­lim­i­nary, it nev­er­the­less il­lus­trates the scale of the chal­lenge fac­ing OPEC oil pro­duc­ers, and par­tic­u­larly Saudi Ara­bia, upon whom the largest cuts will have to be borne.

OPEC pro­duc­tion surges

Pro­duc­tion from 14-mem­ber OPEC broke a new record in Septem­ber, climb­ing by 170 kb/d to 33.64 mb/d. Boosted by re­turn­ing crude flows from Libya and ris­ing Iraqi pro­duc­tion, OPEC out­put in Septem­ber (ex­clud­ing new mem­bers In­done­sia and Gabon) stood al­most 0.9 mb/d higher than a year ago. Saudi Ara­bia, Kuwait and the UAE con­tinue to pump at or near record lev­els. Mean­while, sup­ply from Iran con­tin­ues to in­crease, reach­ing 3.67 mb/d in Septem­ber. Iran has brought back on­line around 760 kb/d of crude sup­ply so far in 2016, which is the fastest source of OPEC growth this year.

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