OPEC deal: One year over, another left

TODAY, OPEC ministers and their counterparts outside the group will celebrate a special occasion in Vienna’s historical Palais Niederösterreich: The end of the first year of the production-cuts agreement. A year ago, OPEC and another 11 producers led by Russia agreed to curtail daily output by 1.8 million barrels until December this year.

They changed their minds in May and decided to extend the agreement until March next year.

Surely, it was an exciting ride for both parties. Due to the cooperation between the 24 producers involved, the market went from turmoil a year ago to a stable and bullish one.

Due to the cuts, the overhang in oil inventories went down from around 340 million barrels early in the year to just 140 million barrels above the five-year average in October.

Demand is also in good shape; the supply-demand balance is fluctuating between deficit and a small surplus; and the outlook for prices next year has never been better since 2014, thanks to the “declaration of cooperation” among OPEC and non-OPEC.

Now as the 24 producers are about to finish their race to rebalance the market, they still have extra miles to run before reaching the finish line of the agreement.

The 24 producers will meet tomorrow, Nov. 30, to agree on a new milestone in their agreement. They will consider extending the current agreement but the duration of that extension is still not determined.

Some sources are suggesting a six month extension to give Russian companies more space to increase their production next year, while others are saying that there will be no surprises and the extension will be for another nine months.

It is truly hard to predict the outcome of the meeting and that applies to everyone from analysts to big banks such as Goldman Sachs who was sure a few weeks ago about the extension for nine months but now seems less so.

Citigroup is still holding the same views and expecting a decision on how long to extend, to be delayed until the first quarter of next year so that producers can have a better understanding of the market.

Regardless of the rhetoric, common wisdom supports both scenarios.

If OPEC and non-OPEC decided to extend for just six months, that might work just fine.

Currently, the overhang in oil inventories in OECD countries is around 140 million barrels — that is assuming OPEC’s calculation is correct.

This means that six more months of cuts are needed before oil stocks will go back to their average of five years, with the assumption that compliance with the cuts is at 100 percent and supply from outside the group and from Libya and Nigeria isn’t growing by a worrying level.

The other scenario, which is the most likely one, is that everyone goes for nine months because Libya and Nigeria might increase their production further and higher oil prices will allow more supply from North American shale oil wells.

Both scenarios will work just fine for OPEC and for nonOPEC (except for Russia) and any extension above three months will also do just fine.

The only challenge for all is how to finish the race.

Some sources are suggesting that OPEC wants producers to raise production gradually toward the end of the agreement and that would be the best case for the exit strategy from the deal.

Russia and some other non-OPEC countries may find this exit strategy a bit strange as they want to have something clear and written.

Having something written is problematic also because OPEC and Russia said before that efforts will continue until the goal of the agreement is met, so without a clear understanding of when the market will rebalance, producers will need to keep their output restraint indefinitely.

In all cases, what OPEC and Russia need to focus on is improving compliance rates over the coming few months, and they need to keep all the options open for cooperation in the future.

No one is able today to predict the situation in the market and some research houses have advised OPEC’s officials in Vienna this week that they might need to consider managing the supply in the market in 2018 and 2019 because non-OPEC supply is expected to keep growing until 2020.

It is unlikely that Russian oil companies would like to extend cuts beyond 2018 as it will take a lot of political efforts to bring them on board next year, let alone in 2019.

The only comforting factor is that in Russia, all companies listen to president Vladimir Putin who has the final say on oil policy.

Next year will also be challenging, as expectations for nonOPEC supply are not yet clear and estimates of many analysts range from 700,000 to close to 2 million barrels a day of oil. So no one knows for sure if 2018 will finally be the year of “market rebalancing” as the UAE energy minister stated or if it will be just another year.

Until now, the market and producers aren’t expecting any cooperation beyond 2018 — but only the next 12 months will tell.

Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi

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