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OPEC Overcompliance Has Created A Problem

Courtesy of Irina Slav, OilPrice.com

Crude oil inventories in the Organization for Economic Co-operation and Development have fallen below their five-year average level, a high-ranking OPEC official told S&P Platts this week. They are now 20 million barrels below that average, the source said, thanks to OPEC’s over-compliance with the production cuts.

The news comes amid reports quoting Russia’s and Saudi Arabia’s energy ministers as saying they are negotiating a ramp-up of production ahead of the end-2018 deadline. The reports began emerging after Brent hit US$80 per barrel and India’s Petroleum Minister Dharmendra Pradhan called Saudi Arabia’s Khalid al-Falih to reiterate his government’s insistence on “stable and moderate” oil prices.

Was a phone call all it took for Al-Falih to make a U-turn in his statements regarding oil prices and start assuring the market that there is sufficient supply and there is no reason why Brent should trade above US$80? Probably not, although India is among Saudi Arabia’s largest clients, and its demand for oil is growing at the fastest pace in the world.

OPEC has been monitoring OECD inventories closely, and not just because its target in the cuts was the OECD inventory five-year average. There was talk a few months ago that this five-year average may not be the best measure of global oil supply. That talk was prompted by data suggesting the inventories were not falling as fast as OPEC had hoped, but with Venezuela’s production in a free fall, things settled and prices took off.

Now, after it became clear that Moscow and Riyadh are talking about a possible increase of 1 million bpd, oil prices lost all they had gained since the beginning of the month within a week. Perhaps the time has come for some urgently needed bullish oil news, such as the clearing of the glut. After all, before Al-Falih had assured India there will be enough oil, there were reports about Saudi officials admitting the Kingdom is targeting US$80 a barrel or higher to boost Aramco’s valuation.

While the OECD inventory target has been met, US$80 is seeming increasingly unlikely, despite some figures, including Goldman Sachs, continuing to be bullish on oil. As Russia’s Alexander Novak told Bloomberg on the sidelines of the St. Petersburg Economic Forum, no decision on increasing production has been made yet. It will be made in June, when OPEC+ meets to discuss the matter further.

There is also reason to be bullish for the fact that, according to some analysts, the additional supply that OPEC and Russia plan to bring online would “barely” compensate for the loss of production from both Venezuela and Iran.

Any optimism, however, should be cautious. U.S. production continues to grow and exports are also set for a further increase: June shipments are projected to hit 2.3 million bpd, of which 1.3 million bpd will go to Asian buyers. U.S. crude is cheaper than both the OPEC basket and the Russia Urals benchmark, so it would be eating directly into OPEC+’s market share. This is cause for concern in the cartel and in Russia, which has already made it very clear it would be happier with oil at around US$60 a barrel rather than US$80.

The decision to keep cutting or start ramping up needs to be unanimous, UAE’s Oil Minister Suhail al-Mazrouei told media this week. There is hardly any chance for surprises, however. So far, the cartel has gone where Saudi Arabia has wanted it to go, some more willingly than others, but still together, as higher prices are generally good for oil-dependent economies. But now, the memory of oil at US$30 is still too fresh, and a lot of oil consumers enjoyed faster economic growth thanks to cheap oil—they may be unwilling to pay so much more so soon.

OPEC is once again between the rock of U.S. shale production and exports, and the hard place of budget gaps and investment projects that need funding.


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