Conventional wisdom now holds that OPEC won’t have a choice when it meets next on May 25. Because today’s glut is proving so stubborn and stock draws won’t gain momentum until the third quarter, OPEC will have to extend the supply pact it agreed to in November, which limited production for the first half of 2017 with the help of non-OPEC producers.
Without a doubt, abandoning the hard-fought deal would be a disaster. Failing to renew it would sound the starting bell of another oil market battle royal. Thus, OPEC and friends, led by Saudi Arabia and Russia, have to extend their deal just to protect oil prices from sagging more.
If an extension is virtually guaranteed, then the question is: How much more effective can the cuts be? Looking forward to the second half of this year, the global supply-demand balance is widely expected to tighten. Seasonal demand in key markets such as the U.S. should rise enough to put a dent in closely-watched oil stockpiles; elsewhere, a lack of investment and natural declines are limiting output in major and marginal producers (e.g. China, Colombia, etc.).
From OPEC’s perspective, these trends are all encouraging. But wild cards are also at play. Taken together, they have the potential to seriously undermine the historic supply pact.
As far as spoilers go, Libya has the most potential. Just this week production jumped some 270 thousand b/d—practically overnight.
Presumably, the members that were given a free pass in November will be allowed to pump what they wish—circumstances permitting—for the duration of the extension. This is where things get dicey. Libya and Nigeria were not bound by the deal because their respective oil sectors were literally under siege last year. These countries cut production involuntarily so OPEC did not ask them to contribute. Prospects in both countries have improved lately, however, while Iraq’s commitment to the pact has been called into question.
As far as spoilers go, Libya has the most potential. Just this week production jumped some 270 thousand b/d—practically overnight. 2017 has been a tough year for the North African producer, with rival factions fighting over oil terminals and vital bottlenecks being shut. Yet production now stands at 760 thousand b/d—the highest level in three years. Libya’s NOC wants to boost production by an additional 350 thousand b/d this summer.
A sustained Libyan comeback would be a miracle, but for OPEC, it would be a nightmare. Right now, Libya is planning to double production from levels that prevailed in November, when OPEC agreed to output quotas. Should the country succeed, it would more than offset cuts made by Saudi Arabia, which slashed the most on a volume basis (more than 500 thousand b/d). Libya is closer than ever to healing the east-west divide that pitted a UN-backed government in Tripoli against an eastern strongman all of last year. Political stability at the national level would make the oil sector considerably safer, although local grievances could still handicap production on a case-by-case, day-to-day basis. Remember, Libya has a history of surprising the market.
Nigeria’s upside potential
Then there’s Nigeria. OPEC’s secondary sources put oil production at 1.5 million b/d for much of the last year, making it the second-largest crude producer in Africa. But that number would be closer to 1.8 or 1.9 million b/d (excluding lighter condensates) if not for a surge of militant activity going back to February 2016. When the Trans Forcados pipeline was sabotaged last year, it cost Nigeria roughly 250 thousand b/d in oil exports. The pipeline may or may not return next month, as planned, but even a delayed restart would limit the impact of cuts by others.
While there may be technical hiccups, the political conditions for a Nigerian comeback are in place.
While there may be technical hiccups, the political conditions for a Nigerian comeback are in place. Militants have held their fire so far this year, in large part because of sustained government outreach, which was absent before. Nigeria’s militancy problem is more than a decade old. The imperfect solution, adopted in 2009, was an “amnesty” deal that paid militants not to blow up pipelines. President Muhammadu Buhari ended that scheme shortly after taking office in 2015. Immediately thereafter, new militant groups sprang up, promising to cut off oil exports so long as the Delta remained poor and polluted.
Attacks continued through late last year, but outreach efforts led by Vice President Yemi Osinbajo gained momentum this year. Whereas President Buhari avoided the Delta and promised force rather than dialogue, Osinbajo started making regular visits. The lawyer-pastor-politician listens carefully and appears sincere; he even acknowledged that black market oil bunkering is a vital part of the Delta’s economy. Osinbajo’s plan is to put locals to work at much safer modular refineries instead. Alongside these efforts, the government restarted amnesty payments, albeit in fits and starts, and promised more development. Precisely because hopes have been raised, militants have stopped attacking the oil industry—for now. Can the government improve conditions before the public’s patience runs out again? We’ll see. Like Libya, the potential is there and the political atmosphere is improving.
Questions about Iraq
Another wild card this time is Iraq. It wasn’t until days before OPEC finalized the supply pact in November that Iraqi politicians, namely Prime Minister Haider al-Abadi and Oil Minister Jabbar al-Luaibi, endorsed the deal. They were reluctant at first, but ultimately concluded that cutting production would increase revenues so long as prices climbed. However, inside Iraq, the debate over output cuts continues and officials have sent mixed signals going back months.
Iraq swears it’s cutting enough, although OPEC’s secondary sources, which Iraq rejects, have cast doubt on that claim.
Iraq swears it’s cutting enough, although OPEC’s secondary sources, which Iraq rejects, have cast doubt on that claim. Meanwhile, Iraq’s oil marketers have raised eyebrows with curiously high export loading programs, which suggest Iraq is less than eager to cut back. More recently, notable Shia politician Ammar al-Hakim—who heads the National Alliance, to which Prime Minister Abadi belongs—reiterated his position that Iraq should get a free pass. Hakim may not have final say over oil matters but he is influential enough that OPEC Secretary-General Mohammed Barkindo met with him in October and April.
Together, these three wild cards—Libya, Nigeria and Iraq—can weaken the OPEC/non-OPEC deal. In combination with robust U.S. shale oil production, they could force OPEC and its allies to go back to the drawing board.