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Gregory Brew

Gregory Brew

Dr. Gregory Brew is a researcher and analyst based in Washington D.C. He is a fellow at the Metropolitan Society for International Affairs, and his…

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OPEC Aims For Smooth Exit From Production Cut Deal

OPEC

The members of OPEC are quietly beginning to plan an eventual tapering-off of production cuts, even as the group plans a nine-month extension of the cuts to the end of 2018, according to Bloomberg.

The secret discussions aim to ensure that production comes slowly back online as the cuts expire, avoiding a market shock and the pump-at-will policies from producers that triggered the 2014 price collapse.

Speaking at an investment conference in Riyadh, Saudi oil minister Khalid Al-Falih emphasized the group’s focus on reducing OECD inventories, which remained far above their five-year average. The cuts currently in place expire in March 2018, but the group is considering extending them. Al-Falih noted that as they approach the five-year average in inventories, OPEC will begin to consider how to “smoothly exit the current arrangement,” according to Reuters. A sudden end to cuts would flood the market and potentially produce another collapse in prices.

Prices have edged upward in recent weeks thanks to declining U.S. inventories and strong signs of OPEC members’ compliance with the cuts, which were renewed last May and could be renewed again this November, when OPEC holds its annual meeting in Vienna.

But the need for a clear exit strategy was abundantly clear in June, when the price fell after the cuts extension, in part because it wasn’t clear what OPEC’s long-term strategy was, beyond extending the cuts and hoping the market would eventually balance.

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Now, the group seems more confident. Analysts expect OPEC to extend the cuts another eight or nine months from this November, while OPEC’s internal forecasts estimated fuel surpluses will be eliminated in the third quarter of 2018. Extending the cuts was hinted at for weeks, but on October 18 the news officially broke that OPEC was “favorable” to another nine-month extension. Prices have risen appreciable since the news came out.

After stagnating in the mid-$40s for much of the summer, WTI prices were at $52 on October 22-23 as investors appeared confident that OPEC member compliance was steady. Along with non-OPEC allies participating in the cuts, OPEC has cut about 1.8 million bpd and has succeeded in record-high compliance levels. OPEC’s Joint Ministerial Monitoring Committee reported that inventories have decreased to 159 million barrels above the five-year average. That’s down from 340 million barrels above the average in January 2017, a clear sign that the cuts are having an effect on inventories.

Prices rose fairly steadily over the last few weeks, though declining inventories in the U.S. and the possibility of an outage in Northern Iraq have increased upward pressure.

Some investors are bullish, others bearish. OPEC, of course, strives to promote the positive impact of its policies on the market, but it needs the acquiescence of its key members to make a cut extension a success. Small producers like Qatar, which is still suffering from a blockade by its powerful neighbor and OPEC de facto leader Saudi Arabia, have already indicated willingness to extend cuts.

OPEC’s secretary general Mohammed Barkindo told reporters last week that a suggestion from Russian president Vladimir Putin that cuts should be extend all the way to the end of 2018 was being taken “seriously,” according to Reuters. Russia is an important non-OPEC ally and has cooperated with Saudi Arabia to manage the cuts and ensure compliance. If Saudi Arabia and Russia both agreed that a cut extension was necessary, it’s likely they could carry the rest of OPEC and NOPEC with them.

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Both Barkindo and Al-Falih have remained circumspect in public, noting that a decision to extend cuts past March 2018 could come at the November 30 meeting or later, perhaps in early 2018. They’re likely keeping their cards close to the chest in order to measure the impact on the market, which has proven responsive to OPEC rhetoric in the past.

OPEC will likely continue to play coy about extending the cuts until the Vienna gathering. The quiet discussion around an exit strategy could be a sign that an extension is not, in fact, a sure thing, as OPEC plans what to do when the cuts expire. Yet the gradual uptick in prices and strong compliance from OPEC and NOPEC members indicate that keeping the cuts in place would do more good than harm, at least from OPEC’s perspective. More will become clear as the Vienna meeting draws closer.

By Gregory Brew for Oilprice.com

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