The Fuse

OPEC Mulls Output Increase, Prices Could Swing Either Way in Response

by Matt Piotrowski | June 12, 2018

Expect the barrage of OPEC headlines to continue: The next ministerial meeting is next Friday, June 22, which will follow a two-day summit in Vienna, where international oil companies, energy ministers, and market analysts will be in attendance.

Cartel members are split over whether to change strategy, as global oil markets are trading just under $80 per barrel and consuming countries are pressuring producers to increase output. Saudi Arabia and Russia—the leaders of the OPEC+ alliance—are open to the idea of the group boosting production by perhaps as much as 1 million barrels per day (Mbd) to cool the price rally and offset production losses, particularly in Venezuela and Iran. At the same time, however, Iraq and others have expressed their disdain for changing strategy.

OECD commercial stocks are at their lowest levels in three years and now below the five-year average, largely as a result of OPEC’s production agreement.

On Monday, Bloomberg news reported that Saudi Arabia increased output by 162,000 barrels per day (b/d) in May to above 10 Mbd, and Russia has upped its supply to the highest levels in 14 months. Interestingly, Deputy Crown Prince Mohammad bin Salman and Russian President Vladimir Putin will share a box at the World Cup opening match between their two countries on Thursday. They are likely to discuss the agenda for OPEC+ and perhaps agree on a strategy moving forward to suit their interests.

Iraq’s oil minister, meanwhile, warned that the entire agreement—which reduces output by 1.8 Mbd—could fall apart if countries unilaterally increased production. Iraq “rejects unilateral decisions made by some producers which do not consult with the rest,” he said. His comments come soon after Iran and Venezuela voiced similar reservations. It is unclear whether both sides are simply posturing ahead of negotiations or their hardened positions will undermine talks. Though the least likely scenario, an inability to compromise could, counterintuitively, possibly lead to a sharp price drop.

OPEC and its non-OPEC allies will be meeting as the market has clearly tightened with inventories having fallen sharply. According to the IEA, OECD commercial stocks are at their lowest levels in three years and now below the five-year average, largely as a result of OPEC’s production agreement. The situation may worsen as geopolitical risk increases and demand continues to rise. Venezuela’s production is already 550,000 b/d under its OPEC quota, and the IEA says it is expected to decline further throughout the rest of 2018. Iran’s exports are likely to drop as sanctions are re-implemented. At the same time, Mexico, Angola, Nigeria, and Libya have become inconsistent and less reliable. The list of supply concerns comes at the time global oil demand is set to soon surpass the 100 Mbd mark.

If OPEC+ members decide to increase supply, they will likely be lauded as good stewards of the global economy and considered friends of consuming countries. That is a false narrative.

If OPEC+ members decide to increase supply, they will likely be lauded as good stewards of the global economy and considered friends of consuming countries. That is a false narrative for several reasons. First, as of now, OPEC’s compliance with the November 2016 agreement is 172 percent. A production rise would simply boost supply back to the agreed levels. In other words, the group is still juicing the market by producing lower than 2016 baseline. Second, an output increase would reduce spare capacity. The IEA says effective spare capacity is now at only 3.5 Mbd, with most concentrated in the Middle East. This is already a precarious level given the potential for more outages. Third, OPEC’s actions have created the current circumstances—a lower inventory cushion for the industry to respond to shocks and higher pump prices for consumers—a reminder that the global oil market is unfair and unfree.

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