The oil market has already factored in an extension of the OPEC deal, with the working assumption that the cuts will be extended through the end of 2018. But what if OPEC disappoints and extends by a much shorter period of time, or worse, fails to agree to anything at all?
Given all of the bullish rhetoric around the extension from the most powerful members of the deal (Saudi Arabia and Russia), an extension still seems the most likely outcome of the upcoming meeting in Vienna on November 30. But it is not a foregone conclusion.
Russian President Vladimir Putin upped the stakes when he said last month that Russia was open to an extension through the end of next year. That became the baseline assumption in the oil market after other OPEC officials seemed to approve of the proposal. But Bloomberg reported on Tuesday that Russia isn’t there yet—and that top Russian officials believe that it is “too early to announce anything this month,” according to two people familiar with the thinking in Moscow. The logic is that the current deal still runs through March 2018, so why not wait and see how things progress? What’s the rush?
And even though Russia seems inclined to go along with the extension, its leadership is not convinced that a full year is the best course of action. Bloomberg said that these issues were up for debate at a meeting with several Russian oil executives—including those from Gazprom Neft and Lukoil—and that talks were ongoing.
Backing up the hesitation is a comment from Lukoil’s CEO from October, in which he said that the OPEC deal should not be extended if oil prices hit $60 per barrel. Rosneft CEO Igor Sechin also warned against allowing for the revival of U.S. shale. Yet another warning came from Russian energy minister Alexander Novak in October, when he said that Russia would ramp up production in 2018 if the OPEC/non-OPEC coalition couldn’t agree to a deal.
The thing is, OPEC published figures in its latest monthly report that suggested that demand was strong and that global inventories would decline at a pace of 0.67 mb/d in 2018, potentially tightening the market a lot more than expected. That would undermine the rationale for longer cuts. “The latest OPEC figures could be interpreted as weakening the case for such a deal to already be agreed at the upcoming meeting,” JBC Energy GmbH said in a report. Obviously, the IEA has an entirely different take, downgrading demand growth for this year and next, a move that sent oil prices sharply down on Tuesday.
Again, an extension still seems to be the most likely scenario. But the problem for OPEC is that after having raised expectations so far, there’s little room for a softer deal without leading to a sharp selloff.
OPEC’s Secretary-General Mohammad Barkindo told reporters earlier this month that there isn’t “any party that is objecting to extending the supply arrangement.” He even said that other countries could join in the effort, raising the prospect of even deeper cuts.
In fact, the 20 percent increase in oil prices since September is at least partly attributable to rising expectations regarding an OPEC extension. While inventories continue to decline globally, offering some fundamental justification for higher prices, the rapid run up in benchmark prices was likely accelerated by speculators betting on a bullish outcome from Vienna. After having already hyped an extension to such a large degree, anything other than an extension through the end of December 2018 would be viewed as a massive disappointment—and it would likely result in a serious decline in oil prices.
“Any postponement in deciding a supply-cut extension, or even a disappointment relative to the duration of an extension, can easily lead to unraveling of speculative length on futures and a price correction,” Harry Tchilinguirian, head of commodity-markets strategy at BNP Paribas SA, told Bloomberg. Related: Falling Iraqi Oil Output Drags OPEC Production Down
Analysts with Citigroup agreed. “There is an exuberance in the market about there being a done deal to extend through the end of 2018 and I think there’s likely to be disappointment in that come Nov. 30,” Ed Morse, head of commodities research at Citi, told Bloomberg earlier this month. “Our base case is that we do not get a full-year extension on Nov. 30.”
Then there is the small matter of Saudi Arabia and Iran engaging in a proxy war that risks blowing up into something much worse. It’s very unclear how this plays out. Some analysts argue that a full out war that caused disruptions in the Strait of Hormuz, for example, would send oil prices up to $200 per barrel. That is a worse-case scenario that appears very unlikely at this point. The flip side of that is escalating tension between the two countries—OPEC’s first and third largest producers—that undermines the cohesion within OPEC, which could ultimately contribute to a lot more cheating. The unraveling of cooperation and a return to more aggressive production strategies would send oil prices careening down below $50.
Between these two dire scenarios, the more likely outcome is an extension. But a growing number of analysts are wondering if OPEC can seal the deal.
By Nick Cunningham of Oilprice.com
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