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.
Last year ended on a sour note for the oil-producing members of OPEC and their non-OPEC allies with the price of global benchmark Brent crude oil futures falling below $50 per barrel for the first time since mid-2017. The price slump was the market’s initial response to the hard-won agreement by 24 oil producers in Vienna to slash their production by a combined 1.2 million barrels per day (mb/d) for an initial six months from January 1 in an effort to drain the excess supply that had weighed on markets toward the end of 2018.
Production figures for December show that the 11 OPEC members party to the deal took action even before the agreement came into effect, slashing supply by 850,000 b/d, with Saudi Arabia accounting for 65 percent of the total. Roughly 800,000 b/d more will have to be drained from the market if OPEC is to attain the new target of 25.9 mb/d. The reduction was a calculation from an October baseline, but, since Qatar has quit OPEC, the number excludes Qatari production of just over 600,000 b/d. Iran, Libya, and Venezuela are excluded from the agreement and it is not yet known how much each of these three troubled countries will produce in the months ahead.
The 40 percent decline in oil prices from an October 2018 high above $85 per barrel (/bbl) was an indication of traders’ skepticism that the expanded oil producers’ club would deliver on the promised oil production reductions. This sentiment was due largely to doubts as to Russia’s commitment to the deal and suspicions that some OPEC members, Iraq among them, may not adhere to their newly assigned output targets. The vague communique issued by the group of OPEC and non-OPEC members on December 7, 2018 after what was arguably one of the group’s most contentious meetings didn’t help. The statement and subsequent news conference were thin on detail. Individual production quotas for the 24 producers party to the agreement were not revealed and there was no acknowledgement of the exemptions granted to Libya, Venezuela, and Iran. Indeed, the behind-the-scenes discussions that delayed the final accord threatened to fracture OPEC even further when Libya reportedly threatened to follow Qatar and leave OPEC if it did not win an exemption while Iran stood its ground despite an initial refusal by Saudi Arabia to agree to its request for a waiver. Saudi Minister of Energy, Industry, and Mineral Resources Khalid al-Falih reportedly told his Russian counterpart, Minister of Energy Alexander Novak, who was acting as mediator, that Iran could leave OPEC if it was unhappy with the deal on offer. He later relented and agreed to the exemption for Iran.
Also unclear was the producers’ goal with an agreement that essentially benefits higher-cost producers such as shale oil and deep-offshore operators. OPEC and its allies did not provide a preferred price target, nor did they make any reference to global inventory levels, which were on the rise toward the end of 2018. According to the International Energy Agency, OECD inventories rose above the five-year average in October 2018 for the first time since March. OPEC has in the past made clear that it prefers to see inventories fall to the five-year average or even lower to discourage stock building, which tends to weigh on prices and market structure when too high. Of course, the level of inventories is determined by the volume of excess supply, which in recent years has been fed by a large dose of U.S. shale oil. Supplies of U.S. shale oil have grown relentlessly regardless of price with more innovative technology, thereby forcing OPEC to act more aggressively to balance markets even at a cost of losing market share.
Market sentiment has turned positive since the end of the year slump as OPEC’s December 2018 production and export figures as reported by secondary sources in recent days showed the cuts already implemented by OPEC members. Still, the market remains volatile amid fears of an economic slowdown in China, the largest importer of crude oil, much of it sourced from the Middle East. The price of benchmark Brent crude oil, which had risen by $10/bbl since the start of 2019, fell back after trade data this week from China suggested weaker economic activity by the Asian economic giant. Although Iran and Libya are not party to the Vienna agreement, uncertainty over the impact of U.S. sanctions on Iranian oil exports beyond May, when waivers granted to eight countries expire, and a lack of clarity on Libyan production, where oil field shutdowns due to internal strife have hit overall output, are other factors that have contributed to volatility. Falih, speaking in Abu Dhabi, said he was concerned about this price volatility, referring to the swing from a high above $86/bbl in October 2017 to below $50/bbl at the end of December 2018 for benchmark Brent blend crude oil. Producers, he said, should do more to narrow the gap.
But Falih also said the oil market was on track and would quickly return to balance thanks to the commitment by producers party to the Vienna agreement to remove 1.2 mb/d from the market for six months starting in January. “Demand growth remains healthy with forecasts in the 1.3 to 1.5 million barrels per day range, while supply is starting to reflect the impact of our adjustments,” he told an energy industry event in Abu Dhabi on January 13. These adjustments, he added, would eventually be reflected by inventory levels. Falih had made it clear in previous comments that Saudi Arabia, by far the largest producer and exporter within OPEC, would do whatever was necessary to balance markets, remarks that were interpreted as bullish by the markets in early January, when prices began to rally.
Iran’s exports have been curtailed by U.S. sanctions that came into effect in November 2018 and have fallen by more than 1 mb/d from pre-sanctions levels, though they are expected to rise in the first quarter as buyers granted sanctions exemptions resume purchases of Iranian crude. But what happens after the waivers expire in May is still not known. The U.S. special representative for Iran, speaking also in Abu Dhabi, said the United States was not looking to grant more waivers to importers of Iranian oil. The United States’ stated goal when it imposed tough new sanctions against Iran’s energy, banking, and shipping sectors in November 2018 was zero exports from Iran. Oil prices responded by moving sharply higher and prompted action by Saudi Arabia and other OPEC producers with spare capacity to boost output to make up for the anticipated shortfall from Iran. The surprise waivers granted by Washington just days after the sanctions came into effect sent mixed signals to the market and resulted in the glut that OPEC and its allies are now trying to mop up.
Key to securing the agreement in Vienna was Russia’s role as leader of the non-OPEC bloc and as mediator. Novak pledged a cut of 228,000 b/d, roughly half of the total non-OPEC share, though he has since made clear that this would be a gradual reduction. Novak said on January 11 that Russia would trim production by 50,000-60,000 b/d in January and reach the target over several months. Falih, in Abu Dhabi, made no secret of his disappointment over the delay by Moscow in implementing the cuts fully but added that he expected Russia to catch up and make a positive contribution to balancing the market. Whether this suggests a slight strain in the newfound alliance between the two energy giants remains to be seen but it is no secret that Russian oil companies are not keen on cutting production given the technical challenges specific to Russian oil fields.
Another major concern for the success of OPEC’s strategy is U.S. oil production growth. The outgoing OPEC president, Suhail Mohamed Faraj Al Mazrouei, the UAE’s minister of energy, has said in recent days that U.S. shale production growth and U.S.-China trade relations are the main areas of concern.
The United States is now the largest oil producer in the world ahead of Russia and Saudi Arabia and as such can influence markets even though it remains a modest exporter of crude, at least for now. U.S. oil production surprised to the upside throughout 2018 despite predictions of a slowdown due to infrastructure constraints in the U.S. pipeline systems. The United States’ shale oil and conventional producers, unbridled by any output restraint, are expected to produce an average 12.1 mb/d in 2019, with much of the increase expected in the second half of the year.
OPEC can therefore expect another testy meeting again in April when all these imponderables will come into play again and may force the group and its allies to consider ceding yet more market share to the United States. The agreed cuts should stabilize the market for now but it’s too early to say for how long and at what price. Much will depend on whether the expanded oil producers’ group will stick to its New Year’s resolution.
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