The results of the 2016 OPEC/non-OPEC supply deal speak for themselves. The 24 oil producers that agreed to limit production, led by Saudi Arabia and Russia, mostly kept their word. Looking back at the Vienna Pact’s first 18 months (Jan. 2017-June 2018), overall compliance was extremely high by historical standards, at times surpassing 150%. Global crude inventories have fallen dramatically and prices have climbed to highs not seen since 2014.
Riyadh and Moscow can take credit for establishing what we might call the Super-OPEC framework, also known as OPEC Plus. The goal now is to make the alliance more permanent so it outlasts the supply deal. Yet doing so will be tricky. At a time when OPEC should be declaring victory, it’s suffering whiplash from a change in market sentiment this summer. On June 23, the OPEC-Russia alliance concluded that the oil market was tightening too fast. They agreed to raise production by one million barrels a day (b/d) as a group.
“One million barrels” is a big round number but is it the right number?
Because of its own success, it was widely expected that OPEC and others would agree to boost output in the second half. But how much was enough? “One million barrels” is a big round number but is it the right number? Real, potential and unpredictable supply shortfalls make a “magic number” elusive. Among suppliers, disagreements over rising volumes threaten today’s fragile consensus and possibly the Super-OPEC framework. The problem is that no one knows what to expect from Venezuela, Iran or Libya. Together these countries have lately produced some 6.25 million b/d, about 20% of OPEC’s total.
Venezuela’s slow-motion death spiral continues. Since the start of 2016, production has fallen from 2.3 million b/d to just 1.3 million b/d today. Losing a million barrels of daily output over 2.5 years doesn’t sound so bad, but month-to-month losses have averaged about 50 thousand b/d over the last year. Thus, on an annual basis, Venezuela is on track to lose 600 thousand b/d. That might actually be the best-case scenario.
Venezuela agreed in 2016 to a quota of just under 2 million b/d. By the end of this year it might produce half that.
The latest reports suggest that state-owned oil and gas company PdVSA is under siege. Last month, it was revealed that employees were fleeing in droves and thieves were systematically looting oil equipment. The bureaucracy has endured several purges and “revolutionary” political appointees with no industry experience are in charge. Outside Venezuela the company’s assets are being seized. It is hard to overstate just how bleak the picture is for Caracas. The fact is: Venezuela agreed in 2016 to a quota of just under 2 million b/d. By the end of this year it might produce half that.
The silver lining for OPEC is that Venezuela’s losses—up to now—have been gradual. The market is adjusting. But that is not the case in Libya. Last month, output there was slashed overnight by about 700 thousand b/d. Libya lost in one week in June what Venezuela lost over the last 18 months.
Production plummeted when two major oil terminals came under attack by a faction promising to “liberate” them from a strongman who hopes to be Libya’s next president. Within a week, the attackers were routed and the strongman took the terminals back on June 21, days before OPEC met in Vienna to discuss its supply strategy. It seemed Libya would soon return to business as usual. But the strongman, Khalifa Haftar, had other ideas. He blamed the Central Bank for paying his enemies with oil revenues. To cut them off he decided to cut off oil exports at the five terminals under his control. (See my July 9 rundown for the Fuse.)
A year ago, I described Libya as “OPEC’s involuntary swing producer” and that’s still the case in 2018.
Haftar’s blockade ended on July 11 after some of his demands were satisfied. The original NOC in Tripoli is now getting back to work and shooting for 1.1 million b/d in the coming weeks. But the June surprise attack and the ensuing blockade underscore how vulnerable production is. Countless militias, criminals and activists can shut down fields and pipelines without warning. We’ve seen it many times before. At the national level, Libya is entering a very sensitive phase ahead of elections scheduled for December. Haftar wants to be president. If he likes the results, those facilities under his control could become even more attractive targets. If he doesn’t like the results, another blockade can’t be ruled out. A year ago, I described Libya as “OPEC’s involuntary swing producer” and that’s still the case in 2018.
Venezuela’s shortfalls are real and gradual, while Libya’s are huge and often unpredictable. But it’s still unclear just how much Iran’s volumes will suffer from re-imposed U.S. sanctions. On May 8, President Trump withdrew the U.S. from the Iran nuclear deal. Since then the White House has promised to impose the “toughest sanctions in history”. That is not an idle threat, but other OPEC members can’t be sure of how many barrels Iran will lose or how soon.
A lot of decisions have to be made before OPEC knows how big the sanctions shortfall will be.
Production stood at 3.8 million b/d and exports at around 2.2 million b/d in June, about where they were before sanctions were last imposed in 2012. Iran lost roughly one million b/d of crude exports and production under the previous sanctions regime. There has been much confusion recently because of mixed signals from U.S. officials. Some have insisted that Washington’s goal is “zero” exports by November, which would be an extremely ambitious and disruptive target. That goal has been walked back somewhat. Secretary of State Mike Pompeo now says the U.S. might give exceptions to those countries that significantly cut imports from Iran. But what counts as a “significant” reduction? Under President Obama it was 15-20% every 180 days. Is that good enough for President Trump? We don’t know yet.
A lot of decisions have to be made before OPEC knows how big the sanctions shortfall will be. The Europeans are intent on preserving the nuclear deal and protecting EU companies from U.S. sanctions. In the end, however, volumes will depend on what banks and companies decide is best for them. Iran’s top customers, India and China, are also big question marks. New Delhi is considering a special payment mechanism to keep importing oil from Iran. Beijing already has isolated banking channels to enable sanctioned trade. Given Iran’s predicament, the Chinese might increase imports and soak up displaced barrels, if the price is right.
In that case, Iran’s fellow OPEC members will have much less heavy lifting to do.