The Fuse

OPEC+ Extends Cuts For 9 Months, But Risks Remain

by Nick Cunningham | July 03, 2019

The OPEC+ coalition agreed to extend the production cuts agreement for nine months, committing the group to holding 1.2 million barrels per day off the market through the first quarter of 2020.

The OPEC and non-OPEC group also formalized cooperation going forward, ensuring that nearly half of the world’s oil supply remains under some sort of market management indefinitely. While the result from Vienna is ostensibly a success, there are obvious cracks in OPEC’s cohesion, as well as in its strategy to tighten up the market.

OPEC+ agrees on 9-month extension
There was comparably little fanfare at the OPEC meeting in Vienna this time around. After the recent collapse of oil prices, which saw Brent fall to as low as $60 per barrel in the weeks leading up to the meeting, OPEC members and its non-OPEC partners were constrained in their options. The clear deterioration in the global economy has led to a wave of downward revisions in oil demand from a long list of oil forecasters. Weak demand, low prices and budgetary pressure on producing countries all but assured the outcome of the OPEC+ meeting even before the ministers gathered in Vienna.

The agreement extends the OPEC+ cooperation for “eternity”

The day before the meeting kicked off, Russian President Vladimir Putin announced on the sidelines of the G20 summit in Japan that he reached an agreement with Saudi crown prince Mohammed bin Salman to extend the production cuts for six or nine months. The agreement between the top producers left little drama for the official meeting. Even the uncertainty over whether they would extend for six months or a longer period through the start of 2020 mattered little. The group meets again in six months regardless of the duration of the deal, at which point it can tweak the terms of the agreement. Ultimately, the nine-month extension won out.

In addition to the extension, the group also adopted a charter formalizing the cooperation between OPEC and the group of non-OPEC countries led by Russia. The document lays out an official process and forum for discussions going forward. The agreement extends the OPEC+ cooperation for “eternity,” as OPEC Secretary-General Mohammad Barkindo put it. The initial coming together of OPEC and non-OPEC countries was meant to be a temporary measure to erase the global supply surplus, but their coordination will be a permanent fixture of the oil market going forward.

The irritation from Iran and others was magnified by the fact that Putin and MbS seemed to be the decision-makers, announcing their agreement before OPEC even met

The seemingly dominant role that Russia has played in these negotiations rankled some within OPEC, who have appeared powerless as Riyadh and Moscow do all of the negotiating. “My problem is unilateralisation,” which was “threatening the existence of OPEC…OPEC might die,” Iranian oil minister Bijan Zanganeh said on Monday, before agreeing to the extension. Saudi Arabia sought to downplay the situation. “I don’t think Russia is calling the shots,” said Saudi energy minister Khalid al-Falih when asked about Putin’s role. “I think Russia’s influence is welcome.”

The irritation from Iran and others was magnified by the fact that Putin and MbS seemed to be the decision-makers, announcing their agreement before OPEC even met.

 OPEC’s eroding market share
Procedural challenges pale in comparison to OPEC’s main task: balancing the oil market and pushing up oil prices. The danger of cutting supply only to cede market share to others – namely, U.S. shale – has only magnified since OPEC+’s original deal at the start of 2017. OPEC produced 29.87 million barrels per day (Mb/d) in May 2019, down sharply from the 33.12 Mb/d in the fourth quarter of 2016, just before the initial round of cuts went into effect. Over the same timeframe, U.S. oil production has surged by more than a third from 8.8 to 12.1 Mb/d. As OPEC+ keeps oil off of the market, U.S. shale steps into the void leftover. In the interim, prices are up only slightly compared to two and a half years ago, although there have been multiple boom and bust cycles in that period.

OPEC+ seems caught in a trap, forced to perpetually keep supply off the market in order to avoid a price crash, but the effort is giving more room for competitors. Still, despite the checkered results, few doubt that prices would be much lower if the OPEC+ cuts had not occurred in the first place.

Even in the face of eroding market share and the sacrifice that some producers are making (voluntary, or otherwise), OPEC+ remains firm in its effort to prevent a renewed supply surplus and price downturn. The latest extension amounts to a reaffirmation of the group’s strategy.

Another significant result from the latest meeting in Vienna was Saudi Arabia’s insistence on adopting a new framework for evaluating the surplus. Khalid al-Falih said that the new metric would be weighing inventories against the 2010-2014 average, rather than the trailing five-year period. Because inventories were much lower in the early part of the decade, the strategy shift ultimately means that the group will go much further in draining global inventories. At least, that is, if the Saudi vision prevails. Russia disputes that the 2010-2014 average will become the new standard, with energy minister Alexander Novak saying that no decision had been made.

The gap between the two will need to be resolved in the months ahead, but at a minimum, the statements from al-Falih offer a window into the thinking in Riyadh. Saudi Arabia appears determined to prevent a glut and is clearly aiming for higher oil prices. The urgency is clear. The Saudi budget does not breakeven unless oil prices are in the $80s per barrel. Meanwhile, Saudi Aramco said that it would begin preparing, once again, for an initial public offering, although details remain vague. For Saudi Arabia to gain the most from the Aramco offering, oil prices would need to be much higher.

Fighting for higher prices also means ceding market share and offering a lifeline to struggling U.S. shale drillers

However, Riyadh faces familiar risks. Fighting for higher prices also means ceding market share and offering a lifeline to struggling U.S. shale drillers, many of which are burning through capital. The revenue boost from higher prices, Saudi Arabia clearly thinks, is worth the sacrifice. “I have no doubt in my mind that U.S. shale will peak, plateau and then decline like every other basin in history,” Al-Falih told reporters at OPEC’s Vienna headquarters. “Until it does I think it’s prudent for those of us who have a lot at stake, and also for us who want to protect the global economy and provide visibility going forward, to keep adjusting to it.”

As if to underscore the challenge that OPEC+ faces, oil prices plunged by more than 4 percent on Tuesday, the same day that the nine-month extension was officially announced. Markets were apparently concerned about deteriorating economic conditions and weakening oil demand.

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