OPEC’s Premature Victory Lap
OPEC met on Friday to review the progress of their work over the past 9 months, assessing whether or not they should extend their current production cuts beyond the March 2018 expiration date.
OPEC gathered in Vienna at a time when the oil market arguably looks tighter than it has in a very long time. Demand is growing at a rapid clip – increasing at a 1.6 million-barrel-per-day rate this year – global supply fell in August, and inventories have drained at a much swifter pace in recent months. Kuwait’s oil minister Issam Almarzooq said that global crude and refined product stockpiles have “massively drained.”
“We are on the right track and there is now more light at the end of the tunnel,” Almarzooq said at the start of the meeting on Friday. “This is not the time to take our foot off the accelerator."
Part of the reason for the improved outlook in the oil market is the result of OPEC’s recent performance. Compliance with the agreed upon production cuts jumped at the end of this summer, which also coincided with an unexpected drop in Libya’s output.
One of the top agenda items at the meeting held on September 22 was to monitor compliance, and OPEC officials were clearly much happier than they were a few months ago.
In fact, at its Friday meeting, OPEC took a victory lap of sorts, trumpeting the impressive compliance rate from its members. “OPEC and participating Non-OPEC producing countries recorded the highest conformity ever with their voluntary adjustments in production, achieving a level of 116%” in August, OPEC said in a statement. The improved compliance rate “underscores the resolute commitment of participating producing countries to cooperate towards the rebalancing of the market."
But they are also trying to get a handle on the output of Libya and Nigeria, two countries that were exempted from the deal and have collectively added about 550,000 bpd since the original deal was agreed to last year. That amount has offset about half of the output reduced by the rest of OPEC – the group agreed to cut production by 1.2 mb/d. On Friday, OPEC requested the oil ministers of Libya and Nigeria present their production plans at the meeting in Vienna.
However, the two countries are unlikely to restrain their output, at least for now. At the same time, Nigeria’s oil minister tried to downplay his country’s role as spoiler to the agreement. Emmanuel Kachikwu told reporters on the sidelines of the conference that Nigeria has “effectively joined” the agreement, stating that Nigeria would “cap” its output at 1.8 mb/d. With production currently at 1.7 mb/d, he argued that Nigeria, in reality, is actually complying with the accord, since it is still below that level. Kachikwu said Nigeria would remain below that cap and insisted he supports the OPEC deal.
The big unanswered question, though, is whether or not the OPEC/non-OPEC production cuts should be extended. At this point, most analysts expect a three-month extension, pushing the deal through the middle of 2018.
But recent comments from Iraq’s oil minister suggest that there are other ideas at play – perhaps an extension through the end of 2018, or maybe even deeper production cuts. OPEC reportedly discussed some of these options at its monitoring meeting on September 22, although they did not make an official statement supporting a position.
Russia’s energy minister Alexander Novak told reporters that it was too early to discuss the possibility of an extension.
Goldman Sachs agreed, suggesting in a research note that it would be in OPEC’s interest not to telegraph its intentions too early. Moreover, the investment bank argued that OPEC probably shouldn’t extend its production cuts anyway because the group could cede market share to other producers (i.e. U.S. shale). “[W]hile the decision to cut production to normalize inventories was rational, this strategy should be followed by a gradual increase in production to capture increasing market share and revenues in 2018,” Goldman wrote in a September 21 research note.
The investment bank argued that draining inventories too low would initially benefit OPEC through higher prices, but ultimately OPEC would lose ground as U.S. shale filled the void. Thus, OPEC should let its deal expire and return to higher levels of production. As of now, OPEC does not appear to be in agreement with that view, but we’ll find out more at the group’s official meeting in November.
