Any Oil Production Cut should be by Consensus

In December 2016. OPEC and a group of non-OPEC producers. led by Russia. agreed on a Declaration of Cooperation to stabilise the oil market after prices in January that year fell below $30 a barrel. The agreement stipulated a reduction by 1.8 million barrels a day (mbd) for 2017 and was later extended to the end of 2018. with a provision for a review this month.

There was no definition or a target agreed as to when the market is in balance and the surplus supply is wiped out. However. the level of oil stocks in the IEA countries was generally taken as an indicator to see how the agreement is performing. This objective has been largely met and stocks in the IEA countries are well below their last five-year average. And if things continue this way. they could be drastically below that target.

 As for prices. the agreement has done wonders. Just the anticipation of one pushed prices to over $50 by December 2017 and the price of Brent crude oil now is $73.22 from just above $80 a few weeks earlier.

The market has been helped by other factors. such as a reduction in Venezuela’s production and the unstable and below expected production in Libya and Nigeria. There was also the healthy growth in demand through last year. But there was also large increase in non-Opec production. especially from the US with its rising number of active drilling rigs.

Therefore. at this time of festivities related to Eid Al Fitr and the football World Cup. the producers should congratulate themselves on their achievement. The OPEC meeting in about a week’s time. whatever be the outcome. should lay the ground for further cooperation.

But is all this success about to be undone? According to the media. the answer is “Yes“. Collective thinking and decision-making has been the norm throughout the past 18 months. But statements from Saudi Arabia and Russia individually has suggested an easing of the agreement’s goals or abandoning it altogether.

Russia is reported to have already increased production this month to 11.1-mbd. above the level of 10.95-mbd agreed to in the agreement. Saudi Arabia too has increased production. but still within its agreed level.

These signals have been taken negatively by the market and Brent prices have zigzagged downward from $80 to $73 in the last three weeks. with the sharp changes driven by statements from here and there. While some OPEC members silently agree with Saudi Arabia and Russia in wanting to roll back the agreement. others are openly unhappy about such a prospect.

The Iraqi oil minister Jabbar Al-Luaibi told Reuters “a production increase is not on the table as the market is stable and prices are good.“

What make things worse are reports that the US has asked Gulf producers to increase production by about 1 million barrels a day. President Trump repeated his statements on Twitter in blaming Opec for high oil prices and saying that “this is not acceptable“. This will make it much more difficult for discussions at the upcoming OPEC meeting.

The producers. who may have good reasons to increase production. do not want to be seen as towing to the US.

Some analysts are suggesting that there is going to be a shortage once the US sanctions on Iran oil take hold. and that there is likely to be further declines in Venezuelan production. And that non-Opec supply is not going to increase sufficiently for the expected increase in demand.

This is perhaps one reason why prices are not falling further. but the producers cannot get wet before the rain. They should consider all factors. including the possibility of a trade war and its adverse impact on oil demand. A new surge in US production is almost guaranteed with active oil drilling rigs having increased to 862. the highest in three years. and production is already at 10.8-mbd.

Many a time. I have said OPEC and its partners should not suddenly abandon agreed production cuts. No matter what. a gradual exit strategy is well advised. The previous statements from Saudi Arabia and Russia are probably opening salvos to gauge the reaction of the market and other producers.

I am encouraged by the latest statement by Khaled Al-Faleh. the Saudi minister. when he said “it was “inevitable“ that OPECand its partners would agree next week to gradually roll back production cuts. Later. he was said that the meeting would come up with a decision that would make everybody happy. The key words are “gradually“ and “everybody“.

 

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