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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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Here’s Where The OPEC Deal Gets Sticky

OPEC

Oil prices plunged on May 25 when OPEC and its non-OPEC partners extended their production cut deal through March 2018. At the time, the market had not only expected deeper or longer cuts, but also it also wanted to know how the group would return to ramp up production after the pact expires.

Five months ago, the lack of an exit strategy was an equally (if not bigger) worrying sign to the oil market than the slow pace of inventory drawdowns. In managing expectations and communicating a longer-term strategy for after-the-cuts, OPEC failed.

Now, as the cartel and cooperating non-OPEC members discuss yet another extension of the deal—possibly throughout 2018—it looks like they’re determined to have a strategy for a gradual return of production to the market. OPEC and the Russia-led alliance of non-OPEC producers are taking 1.8 million bpd of oil off the market, and a near-instant return of supplies would hurt oil prices and inventory levels, regardless of when it happens.

In addition to the talks about extending the production cuts beyond March next year, OPEC is now holding preliminary discussions on an exit strategy to gradually return production to the market, sources familiar with the talks tell Bloomberg.

While the OPEC/NOPEC partners may approve some of the plan’s key points at the November 30 meeting, the full strategy is unlikely to be communicated to the market until later in 2018, Bloomberg’s sources say.

Related: This Oil Rally May Be Short-Lived

This trickle-out-information strategy is typical of OPEC, which isn’t always keen on sharing its future policies with the market.

The organization’s “whatever it takes” rhetoric was not the “whatever it takes” the oil industry analysts expected in May.

“Neither the length of the extension, nor the compliance rate of its participants, concerns me as much as OPEC’s lack of an exit strategy,” Ebele Kemery, portfolio manager and head of energy investing at JP Morgan Asset Management said when OPEC first extended the cuts.

According to Kemery, OPEC and Russia should have announced that they were working on “a road map for a controlled ramp up of production” to allay fears that they would flood the market with oil, and to put a firm $50 floor under oil prices.

OPEC/NOPEC failed to communicate the intentions of such a plan at the time, and oil prices took a hit. And it wasn’t until the end of the summer when the market started looking tighter that things looked a bit more bullish.

Global oil demand growth turned out stronger than previously expected and the OECD stock overhang dropped to 159 million barrels above the five-year average as of September, from 338 million barrels above the five-year average at the beginning of 2017, OPEC Secretary General Mohammad Barkindo said last week.

This week, it was the turn of OPEC’s most influential minister to declare that the cartel would be working on a “smooth exit” from the deal.

“We are determined to do whatever it takes to bring global inventories down to the normal level which we say is the five-year average,” Saudi Arabia’s Energy Minister Khalid al-Falih told Reuters. Related: The Rise Of The Petroyuan

“When we get closer to that we will decide how we smoothly exit the current arrangement, maybe go to a different arrangement to keep supply and demand closely balanced so we don’t have a return to higher inventories,” al-Falih said, hinting that another type of pact may be up for discussion.

Regardless of how and when OPEC communicates its plan to exit the deal, it needs one. If the organization fails in this as it did in May, oil prices could take another hit and shatter the “price stability” that the cartel is so steadfastly promoting.   

But an exit strategy will likely prove to be a rather daunting task for OPEC. Too slow of a ramp-up of production may boost oil prices to levels too comfortable for U.S. shale producers, and OPEC could lose further market share. A quicker pace of production increase, on the other hand, could tip the supply/demand balance into overhang again, assuming that balance is achieved when the exit plan is launched. At any rate, OPEC needs to have an exit strategy, or at least a strategy to keep the market hooked by insisting that it’s working on one.

By Tsvetana Paraskova for Oilprice.com

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