Until a month ago, oil analysts and investors thought a nine-month extension of the OPEC production cut agreement was a foregone conclusion.
But as the November 30 meeting draws near, oil prices have begun to rally on the back of a growing geopolitical risk premium as tensions rise in the Middle East. In addition, signs of a tighter oil market and of “steadily returning” stability, as OPEC loves to put it, have pushed oil prices to their highest levels in more than two years.
Now it’s those higher oil prices—with Brent trading above $60 a barrel for more than three weeks in a row—that may unravel the OPEC production cut unity and the cartel’s pact with the non-OPEC producers led by Russia.
As they meet in Vienna next week, OPEC and friends face the dilemma of managing (and meeting) market expectations without allowing too much optimism that would boost U.S. shale.
A nine-month extension—which was almost a certainty one or two months ago and which has been largely priced into oil prices already—now looks less certain, or at least OPEC and non-OPEC Russia want us to think so. By managing (i.e., lowering) expectations, they’ll possibly have a contained oil price drop if an announcement next week is underwhelming.
The meeting in May that extended the original pact until March 2018 disappointed the market because that extension was already widely expected, and investors wanted grander “whatever it takes” measures, such as deeper cuts.
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This time around, OPEC producers are expected to go into the meeting happier—with Brent over $60—but if they don’t agree on an extension, they are worried that oil prices could drop, Gary Ross, head of global oil analytics at S&P Global Platts, tells MarketWatch.
Leaving aside the timing of communicating the extension of the deal, the other conundrum is how long that extension should be.
“They’re not sure how long to extend the agreement because…they don’t want to ignite shale” Ross said. “So it’s tricky for them,” he noted.
According to Ross, internal OPEC figures imply that the OECD inventories won’t fall back to their five-year average until September 2018. So there’s a “general belief that OPEC would like to extend the agreement to the end of September, but given the strength in prices, they may be reluctant to do that,” Ross told MarketWatch.
Considering all the dilemmas that OPEC is now facing, their “best game plan” might be to decide to extend beyond March, but decide or communicate the length of extension later, according to Ross.
Over the past month, there have been growing voices that the decision to extend may not come at the November 30 meeting.
Last week, Citi said that the “recent rally in oil prices has been heavily driven by geopolitical risk and increasing optimism on an OPEC deal at the upcoming 30 November OPEC meeting. But Citi analysts believe the latter reason is likely overestimated.”
Citi thinks that “the likelihood of a nine-month extension remains high, but the likelihood that the decision will be deferred until 2018 also cannot be ignored.”
“The market expectation is for an extension through 2018, created by OPEC comments early this fall ... [but] there is increased risk that OPEC delays the extension decision,” Morgan Stanley said in a note to clients on Monday, as carried by Reuters.
Last week, Saudi Arabia’s Energy Minister Khalid al-Falih admitted that global inventories would not have fallen to their five-year average by March 2018, so an extension “of some sort” is needed. Related: Is This The New Sweet Spot For Shale?
Referring to the timing of the announcement, al-Falih—OPEC’s most influential oil minister—told Bloomberg Television in an interview:
“My preference is to give clarity to the market, and announce on Nov. 30 what we are going to do.”
“I’m committed to a full-consensus process,” he said, adding that the cartel would have a “gradual adjustment” kind of exit strategy to avoid flooding the market with oil once the cuts expire.
While Saudi Arabia is working to have an OPEC announcement and to give clarity to the market next week, Alexander Novak—the Energy Minister of Russia, the key Saudi partner outside OPEC in these cuts—has already hinted that the decision could come at a later stage. Moreover, Russian oil firms are said to be balking at a further extension, arguing that their production restrictions are only benefiting others while Russian companies have to cut back from new projects in which they have heavily invested.
Novak will meet Russian producers again this week, while Saudi Arabia will try to reach a ‘full consensus’. At any rate, OPEC and allies have ten more days to manage expectations, and possibly reach some sort of consensus on this much-hyped extension that won’t disappoint oil bulls.
By Tsvetana Paraskova for Oilprice.com
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