Only a select few know what really goes on behind closed doors at OPEC meetings. So trying to put the various pieces of the OPEC puzzle together can be both intriguing and challenging.
Agreeing to agree was a good start at the gathering in late September in Algiers, and at press time, word from the Algerian energy minister was that there might be a second “informal” meeting of OPEC and non-OPEC producers in Istanbul in Octo¬ber. This lowers the risk of the Algiers deal unraveling before OPEC meets formally in Vienna in late November.
Assuming the deal holds, the pause in the push for market share, especially between Saudi Arabia and Iran, comes as a major milestone. Observers may differ on whether proposed production levels repre¬sent a true cut—or a freeze disguised as a cut—but the deal potentially marks the end of a brutal, two-year price-cutting brawl to win market share.
“It’s a matter now of going back to managing the market,” Gary Ross, founder of the PIRA Energy Group consultancy, told Reuters.
Ross believes the agreement to limit OPEC production at 32.5 million to 33 million barrels per day (MMbbl/d)—about a 240,000 to 740,000 bbl/d drop in output from OPEC’s most recent internal report—will accelerate the drawdown of bloated crude inventories. Excess inventories have been eroding since the second quarter and will be gone by the beginning of the sec¬ond half of 2017, he said.
Of course, the extent of the drawdown depends on a host of variables, including the starting point in inventories, OPEC’s adherence to output targets and so on.
Paul Sankey of Wolfe Research is in the more bullish camp, describing the mar¬ket as “near balance, not oversupplied.” Assuming OPEC production is lowered to 33 MMbbl/d and U.S. output rises in response to higher prices in the medium term, the OPEC cut would result in “a faster clean-up of the global crude/product overhang,” he said.
“We will quickly move to a state of global undersupply,” he added. “We will draw down global oil stocks rapidly, start¬ing in the first quarter of 2017, and poten¬tially be at a level the market views as ‘normal’ sometime in the second half of 2017—a year earlier than expected.”
While this is in line with OPEC’s goals, it doesn’t address the motives for OPEC’s change in strategy.
Fatih Birol, executive director of the International Energy Agency, said at the Algiers meeting that, without OPEC inter¬vention, a rebalancing of the market would not take place before the second half of next year. At the same time, he expressed concern that “oil investments will decline for maybe a third year in a row, for the first time in the history of oil, which will have strong implications for markets in the next few years to come.”
So there is anguish over excess short-term supply—and deficient long-term sup¬ply—at the same time?
This brings up the issue of what Simmons & Co. calls the “evaporation of forward oil supply” after 2017.
Next year marks the last wave of project start-ups that were sanctioned at the end of the $100-plus crude oil price environ¬ment. Major project start-ups contributing to global production have averaged a little more than 2 MMbbl/d annually over 2013-2017, according to Simmons. Thereafter, major project contributions due online in 2018-2020 are running at roughly half those levels.
In terms of the Saudi decision to accept a compromise, multiple factors were likely in play. Major producers, such as Iraq and Iran, are thought to be close to max¬imum production; the Saudi economy is under duress, with declining—but still substantial—foreign reserves; and a higher crude oil price would provide a better backdrop to a public spin-off of a 5% stake in Saudi Aramco.
Two other forces may have strongly influ¬enced the decision. First, the Saudi move may have come down to what Sankey calls “cartel economics,” that is, a calculation that the revenue gain from an increase in price will more than offset the loss from selling fewer barrels. The math here had “become compelling,” he said.
A second consideration relates to for¬ward supply. If an OPEC cut is successful in moving oil prices higher—and the cartel accepts that a response by U.S. unconven¬tional producers is inevitable—the outcome may be a cap on oil prices at some point, but also avoidance of a price spike that would endanger oil demand in the out-years when inadequate project start-ups curb con¬ventional global supply.
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