OPEC’s gamble to cut production to shore up prices has not worked out the way members thought it would, but the cartel cannot be faulted for not trying. The inadequacy of its policy in the first part of 2017 means that OPEC will do whatever it takes during the second half of the year to achieve its goals.
Although the Joint OPEC-Non-OPEC Ministerial Monitoring Committee (JMMC) meeting in St. Petersburg on Monday was only to review market conditions and provide recommendations based on compliance levels, a number of OPEC ministers were in attendance and made news. Saudi Energy Minister Khalid Al-Falih said that the Kingdom will restrict crude exports to 6.6 million barrels per day (mbd) in August, down from about 7.2 mbd throughout the first part of the year. Nigeria is reportedly prepared to cap output at 1.8 mbd. In addition, Falih said that his country—and by extension OPEC—will take additional measures if necessary to tighten fundamentals and support prices, arguing that an extension beyond the March 2018 timeframe may be warranted to avoid all producers upping their output at once and causing a price collapse.
The Saudis are in favor of a more aggressive policy to counter bearish factors in order to achieve their desired results.
OPEC, along with a number of non-OPEC producers including Russia, throttled back at the beginning of the year by 1.8 mbd, but prices are lingering below expectations in the mid-to-high $40s. OPEC had hoped for an accelerated rebalancing by draining high inventories and prices to rally to $60, but a combination of surging U.S. shale production, some OPEC players producing above quota, increases in output from exempt members Nigeria and Libya, and stubbornly robust inventories has kept a lid on prices, throwing a wrench in OPEC’s plans. With this, the Saudis are in favor of a more aggressive policy in an attempt to counter these bearish factors to achieve their desired results.
In some regards, the OPEC cut can be considered a failure so far, given that the cartel hasn’t achieved its goals. But the next nine months or so will be an even bigger test, since a number of analysts expect tighter conditions throughout the rest of 2017. “The focus on stronger second half demand that will accelerate the pace of market rebalancing is both supportive and well-grounded in the historical record in our view,” wrote Tim Evans of Citi Futures.
“The focus on stronger second half demand that will accelerate the pace of market rebalancing is both supportive and well-grounded.”
OPEC signaling that the deal will be extended beyond March 2018 may give hedge funds and other traders motivation to bet on higher prices. In the U.S., despite shale’s revival, crude stocks are falling at a sharper rate than previous years, thanks in part to high demand but also significantly lower exports from Saudi Arabia. The third and fourth quarters are also the peak demand period for the year, possibly bringing about more stock draws, not just in the U.S. but also elsewhere. One reason the Saudis are cutting export volumes in August is the result of high domestic demand for power generation (calling into question how effective one month of lower exports will be).
Failure to reach its targets in 2H could bring a wave of disillusionment among oil traders, analysts, and the cartel’s own members.
Failure to reach its targets in 2H, however, could bring a wave of disillusionment among oil traders, analysts, and the cartel’s own members. It’s clear that OPEC producers don’t like the status quo and they need to shuffle things around to underpin prices. But there are a number of competing interests in the cartel that complicate matters. While the Saudis look to restrict exports, Ecuador said it won’t adhere to the deal for budget purposes and Iraq’s compliance is below 30 percent. Libya—and to some extent Nigeria—will continue to pump at higher levels to make up for years of under-production. There are certainly prospects for a tighter 2H, but don’t underestimate the ability of OPEC’s disorder and contradictory signaling—along with U.S. shale—to keep a tight lid on prices.