To cut or not to cut – that is the question for oil producers
Plunging oil prices have a familiar feel. Brent crude dropped this week to below $60 per barrel for the first time since October 2017. Opec and its biggest ally Russia face many of the same fundamental problems they had to confront two years ago. Surging output and a shaky global economy may now require a change in strategy to halt the slide before it becomes unstoppable.
Saudi Arabia’s energy minister Khalid al-falih has pledged the kingdom – which is the world’s largest oil exporter – will ship less crude in December to take into account weakening demand. However, more action may still be required to revive Brent benchmark prices, which have slipped by more than 20 per cent since October, when a barrel of crude was trading at a value above $86.
Opec’s 25-member-strong alliance, known as “Opec+”, of major producers will gather for their final meeting of the year in Vienna on Dec 6, with a decision on whether to cut supplies by 1.4million barrels per day top of their agenda. Saudi Arabia and Russia will have the final say, but there are murmurings within the group that even more action is required to arrest the decline.
“We are highly confident that Opec+ will come out with a firm statement when they meet in Vienna,” said Bjarne Schieldrop, chief commodities analyst at SEB. “They will hold back supply as needed in order to prevent global oil inventories from rising back up again.”
However, any such decision to cut a figure equal to the world’s entire demand growth forecast for 2019 will amount to a dramatic policy aboutturn by the self-styled central bank of oil. Opec had eased back on its cuts in an effort to dampen overheating crude markets. In its defence, some closelywatched market fundamentals now support the argument for a change if Opec wants to avoid a repeat of the price crash which wrecked their economies back in 2014. Most worrying of all for Opec policymakers is the build-up of crude being held in storage, which could be interpreted as early signs of an oversupplied market.
Oil stocks in the OECD countries were probably already above the five-year average back in October and could rise by 700,000 barrels per day in the fourth quarter, mainly due to surging US output, the International Energy Agency said this week.
Failure to win its oil price war with US producers four years ago could be coming back to haunt the cartel, which, allied with Russia, now controls around 45 per cent of the world’s supplies. Output in the US is expected to reach 12million barrels per day in 2019, reinforcing its position as the world’s largest producer of petroleum liquids and potentially Opec’s biggest headache.
Complicating Opec’s decision are waivers granted by the US government to eight major customers of Iran’s crude to continue taking deliveries for the time being despite the imposition of tough new sanctions on Nov 5. The dispensations make it harder to predict how much further Iran’s output will fall. The Islamic republic’s exports have dropped below
2 million barrels per day, from around 2.7million in April.
Angering major consumer nations by boosting inflationary oil prices at a time of economic uncertainty is another major consideration. Donald Trump, the US president, is also likely to continue putting pressure on the group through his Twitter feed and in direct communication over the telephone with Saudi Arabia’s ruler King Salman if it decides on a reversal in strategy by turning down the taps.
Of course, some experts argue that not enough has changed fundamentally in the market to justify
‘Opec wants to avoid a repeat of the price crash which wrecked their economies back in 2014’
a shift in policy. Despite economic uncertainty surrounding trade tariff wars and volatile stock markets, oil demand is still expected to average a record 100million barrels per day this year.
“In reality, core fundamentals have not changed dramatically,” said Chris Midgley, head of S&P Global Platts Analytics. “What has changed, however, is that in October the market was focused on bullish tailwinds, mainly associated with geopolitical risk, while today the market is focused on bearish headwinds from rising production, weaker demand, and higher stocks.”
Goldman Sachs – the Wall Street investment bank which once tipped oil prices to blow past $200 per barrel during the boom – has even blamed the recent sharp crude sell-off on anomalous speculative trading strategies.
In a note to investors earlier this month, the bank borrowed some thinking from Opec’s own playbook of excuses when it wrote: “Driving the most recent leg of the oil sell-off has instead first been momentum trading strategies and, second, increased selling of crude oil futures by swap dealers as they manage the risk incurred from existing producer hedging programmes in a falling price environment.”
Certainly some of the geopolitical uncertainties, which had pushed prices higher, have now eased. Fears that Saudi Arabia would lash out and use its oil exports to hit back at international critics of its leadership following the killing of Jamal Khashoggi in Turkey have eased.
Meanwhile, the kingdom and its Gulf allies may now be forced by increasing international pressure to tone down their regional dispute with Qatar and defuse the conflict raging in Yemen.
The influence of Crown Prince Mohammed bin Salman (MBS) over oil policy in the kingdom will also come under increasing scrutiny in the wake of the Khashoggi scandal.
“Saudi Arabia is currently torn between its desire to have high oil prices and prevent stock-builds and its desire to re-integrate MBS as a world leader despite the murder of Khashoggi,” Olivier Jakob at Petromatrix told S&P Global Platts. “The former requires lower exports, the latter requires higher exports.”
However, for the time being at least, Riyadh’s ideological rift with Tehran is no nearer to being resolved. Iran – currently Opec’s third largest producer – is unlikely to support any cuts to the group’s production unless they are shouldered entirely by Saudi Arabia and its ally Russia.
Senior figures within the group even blame the kingdom for causing a $15 slide in prices due to overproduction. Despite their many differences, both Middle East powerhouses require higher oil prices to keep their petro-dollar economies running.