Long road ahead to reach balance in oil markets
Opec did too good a job managing expectations ahead of its latest meeting in Vienna, which concluded on Thursday. The extension of the deal by nine months, rather than six, was so clearly flagged that oil prices fell 5 per cent on its announcement. Some vague rumours had emerged beforehand, that a longer extension was on the table, that Nigeria might be roped in, or that cuts might be deeper. The market’s reaction probably reflects the liquidation of speculative long positions, held to cover against an Opec surprise.
Instead of a repeat of the initial six-month term, the nine-month period, taking us to the end of next March, is ideal. It allows for spreading adherents’ compliance over a longer period.
Saudi Arabia has been bearing a disproportionate share of the burden. Its domestic consumption goes up sharply in summer because of oil burning to power air conditioning. Crude oil burn last year was down somewhat owing to increased gas supplies and the impact of higher electricity and water prices. But the gas boost will not be repeated this year. A ninemonth arrangement would average out the country’s higher summer and lower winter output.
Somewhat similarly, Russian production usually performs strongly in the second half of the year as weather conditions allow easier drilling. Compliance to its 300,000 barrels per day committed cuts has been very partial; but including the coming winter period will balance out growth over the summer.
Iran’s presidential election is positive for future investment, but it has reached a production plateau for now, and international oil companies will take three or four years to bring on new fields even if they conclude contracts now. So Tehran has lost little from continuing with a cap that is just above the country’s current output.
There was never much prospect that other producers would be brought into the deal, despite the vague chatter over Nigeria, where production cuts from insecurity have eased. Libya likewise remains too volatile to commit to any production level.
Equatorial Guinea has now formally joined the producers’ organisation, but its 12,000 bpd cut hardly amounts to a single well in Saudi Arabia. Turkmenistan, producing some 260,000 bpd, might be leaned on by Russia to turn up next time. Egypt, also mentioned as a possible attendee, could hardly cut since it is a net importer with output in steep decline, but like other non-Opec players, it could volunteer its natural decline as a “cut”.
Opec cannot blame the limited impact of current cuts on poor compliance – members’ adherence to the deal has been well above historic norms, even if Saudi Arabia and a few other members have over-complied to balance out others, such as Iraq. The consistent cooperation with non-Opec players – even if only Russia and Oman have really cut below where output would be anyway – is entirely new.
So it is difficult to see what the next big market-moving Opec ploy could be. Compliance will probably gradually erode this year, but the Saudis, having set their course, will have to tolerate some cheating. No member appears set for big, sudden output gains, although Iraqi capacity will keep growing. Conversely, across Opec and non-Opec, there is little room for deeper deliberate cuts, although political unrest might disrupt Venezuelan exports. Even if stocks are drawing down heavily by next March, the organisation has not laid out an exit strategy – how it will gradually boost output to avoid a price spike or crash.
The planned cuts were simply never very big by historic standards. A planned 1.7 million bpd of cuts, about 1.2 million bpd in practice, are undermined by a projected gain in US production of about 1.4 million bpd since the deal in October. As overstuffed inventories diminish only slowly, Opec is trapped in a long war of attrition.
A planned 1.7 million bpd of cuts, about 1.2 million bpd in practice, are undermined by a projected gain in US production of about 1.4 million bpd since the deal in October