Despite cutting more than half of Saudi Arabia’s current crude oil production, the market response to the attacks on Saudi oil facilities has been muted.
The recent rise in oil prices above $71 per barrel (/bbl) for global benchmark Brent blend futures takes some pressure off OPEC and its non-OPEC partners as the loose alliance of oil producers led by Saudi Arabia and Russia ponder their next move. The price reflects tighter fundamentals thanks to the high level of discipline by the majority of the 24 producers that signed up to an agreement in 2018 to cut oil production by a combined 1.2 million barrels per day (mb/d) from January 2019.
Although the production cut has made for a more balanced market, OPEC lynchpin Saudi Arabia is erring on the side of caution despite some murmurs from Moscow that it may be time to take back some market share lost to the United States and other producers. The signal from Riyadh is that the kingdom, by far the biggest producer in OPEC, would like to see a deeper drawdown in global inventories before deciding whether to loosen the output restrictions at the next meeting of the group of OPEC and non-OPEC members, or OPEC+, in June.
Until then, OPEC and its non-OPEC allies will remain in a holding pattern while keeping an eye out for potential fallout from several directions. The possibility of further disruption from Libya due to the current conflict has kept markets on their toes as has the deteriorating economic and political situation in Venezuela. For OPEC’s analysts, the lack of clarity on U.S. intentions toward Iran once the current waivers granted to eight countries expire in May makes it hard to see a clear path forward. Add to that the International Monetary Fund’s recent downward revision to its global economic growth forecast and it becomes clear that predicting the oil producers’ next move so far in advance of their formal meeting is futile.
The fly in the OPEC and non-OPEC ointment is U.S. shale oil, the production of which continues to grow, albeit at a slightly lower pace than predicted at the end of 2018. The latest forecast by the Energy Information Administration sees U.S. oil production averaging 12.4 mb/d in 2019 and 13.1 mb/d in 2020. Considering that the United States was producing just over 5 mb/d a decade ago and exporting zero barrels, the rapid development of U.S. shale has baffled OPEC and frustrated efforts by the group to drain excess supply from the market and lift prices to levels that would sustain each country’s budget.
A Brent price in the $70-$71/bbl range benefits the hundreds of producers of U.S. light tight oil. This now includes the oil majors who have stepped into the fray to extract U.S. light oil from shale rock, bringing to bear their technological prowess and deep pockets onto the U.S. upstream oil and gas sectors.
The 14 OPEC members, minus those with exemptions, and their 11 non-OPEC partners have generally complied with the production cut agreement. OPEC noted in its latest Monthly Oil Market Report that OPEC and participating non-OPEC countries improved their conformity with their production adjustment in February to almost 90 percent, up from 83 percent in January. Some of the declines in production have been involuntary. Venezuelan output has been hit by blackouts and sanctions that have prevented its state oil company PDVSA from operating its plants and blending its heavy crudes. With Iranian output down, Libyan production threatened by continued military activity, and an uncertain outlook for Algeria after long-term President Abdelaziz Bouteflika stepped down, the oil market has been jittery.
The result has been a shift in the Brent market’s structure, which is now in backwardation, a sign of a tightening market with spot prices trading at higher levels than forward prices. U.S. West Texas Intermediate, however, is still in contango (when the prompt price of a commodity is lower than forward months), reflecting the large volume of oil still slushing around in the United States, though there are signs of tightening there too.
Yet it would be a mistake to look at price movements up or down in trying to assess whether OPEC and its partners are satisfied that their sacrifice has been worth the pain. After all, selling less oil for higher prices is not an unwelcome consequence of the policy, but the loss of market share is, and it may be hard to reverse given uncertainty over demand for fossil fuels in a planet that is going green. Recent remarks by Saudi Arabian Minister of Energy, Industry, and Mineral Resources Khalid al-Falih suggest that he would like to see inventories lower than they are currently.
Strategic stock levels are a more accurate barometer of market conditions and U.S. inventories are of particular interest to markets looking for near-term direction. U.S. crude oil inventories rose sharply by 7.03 mb/d in the week ending April 5, exerting downward pressure on prices before concern over Libyan output kicked in and pushed prices higher.
Falih said in late February he hoped the market would be balanced in April and that inventories would fall to “where we want them to be, which is around the five-year average.”
These indicators will be among factors that will be examined by the next
Joint Ministerial Monitoring Committee of the OPEC+ group when it meets in Jeddah, Saudi Arabia, on May 19. Both Saudi Arabia and Russia, the top two producers in the expanded producers’ club, which have led the drive to shrink oversupply, are members of the JMCC. Iraq, the United Arab Emirates, Kuwait, Nigeria, and Kazakhstan are now also participants. Not all JMCC members are in compliance with the production agreement. Nigeria and Kazakhstan, for example, have yet to comply with their reduced allocations. Their inclusion in the JMCC is likely to ensure they stick to their quotas in the months ahead.
OPEC+ had scheduled a meeting in Vienna for April to determine the course of action for the second half of the year but decided at a March JMCC meeting in Baku, Azerbaijan to postpone the full ministerial. The group will meet at OPEC headquarters in June, by which time ministers expect to have more clarity on the situations with Iran and Venezuela, both OPEC members are under U.S. sanctions with possibly more punitive action to come. The State Department said it will announce by May 2 whether it will extend waivers to some buyers of Iranian crude oil.
The decision will depend on an assessment of whether there is enough oil to offset the loss of Iranian crude should the United States pursue its declared intention of driving Iranian exports down to zero. U.S. officials have been vague when asked whether the waivers would be renewed, though the expectation is that fewer waivers will be granted at lower volumes of imports allowed under the exemptions. The loss of Iranian barrels, with exports falling below 1 mb/d in April, according to tanker tracking data, helped to lift prices. This is more than a 50 percent decline in Iranian oil exports compared with presanctions levels. Should the United States determine that supply is higher than demand in the second half of the year, it may opt for a tougher line against Iran.
Russia appears to have lost some of its earlier zeal for the supply cut agreement. Russian Minister of Energy Alexander Novak, who has been a fixture at all the OPEC+ meetings alongside Falih since the first collective agreement was struck in 2016, is understood to have argued for a postponement of the April meeting. There have been suggestions that the odd coupling with the Saudis may be unraveling, though OPEC insiders dismiss such talk and say the relationship between Riyadh and Moscow is multifaceted and not confined to just energy.
Yet Novak has not come out fully in support of extending the cuts to the end of the year, as suggested by Falih. When asked in Baku whether Russia would support an extension to the cuts, Novak said it was premature to discuss the matter and that any extension would be discussed at the next ministerial meeting.
But as oil prices rise – they are now 40 percent higher than they were in October 2018 – and the world economy is being buffeted by trade disputes, Brexit uncertainty, and geopolitical tensions, there is a risk of a slowdown in global oil demand, which would complicate further the OPEC+ effort to bring about market stability. OPEC in the past week has revised down its demand outlook. In its April oil market report, it cut its forecast to 1.21 mb/d for 2019 from 1.24 mb/d in the March report. It said this was due to slower-than-expected economic activity compared with the expectations of a month earlier. As a result, total world demand for the year is now expected to reach 99.91 mb/d and exceed the 100.00 mb/d threshold during the second half of 2019. The International Energy Agency, which did not change its demand forecast in its latest Oil Market Report, has not ruled out a downward revision in its May report.
For now, firmer oil prices, inventory levels, and the market structure would indicate that the OPEC+ strategy is working. Yet there is a sense among experts within the group that the producers party to the Vienna agreement cannot afford to be complacent nor should they rush to reverse their policy. The market could still spring a few surprises.
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