OPEC takes center-stage as markets await output deal
NBK ECONOMIC REPORT
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.
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.