4 Factors That Could Derail The OPEC Deal

OPEC and its Russia-led non-OPEC allies in the deal managed to stay together for a full year of high compliance with the oil production cuts and have agreed to extend the pact for a second year to the end of 2018.

This year, however, the cartel and friends face even more challenges in sticking together until the end of the December, with both supply and demand uncertainties adding to the unknowns.

On the one hand, within the cartel, possible production slumps from two OPEC members could trigger an early exit. Another internal OPEC factor could be the ever-present possibility that some members may cheat on the production cut deal outright now that oil prices are higher.

On the other hand, factors outside OPEC’s control, such as U.S. shale production expansion and potentially strong global oil demand growth, could also spell the end of the production pact. OPEC could see U.S. shale as rising too much and threatening to eat away at an even bigger portion of the cartel’s market share. Or some phenomenal oil demand growth, stemming from solid economic growth, could help OPEC to accomplish its mission to draw the global oil inventories down to their five-year average somewhere around the time the cartel meets to review the deal in June 2018.

There are four ways in which various political and supply/demand factors could combine to call an early end to the OPEC/non-OPEC cuts, according to Bloomberg’s Grant Smith.

1. Collapsing Oil production in Iran and/or Venezuela

Protests in Iran have been the main theme in geopolitical upside risks to oil prices at the beginning of this year. However, analysts think that immediate supply disruptions out of Iran are unlikely. But the fallout of the protests and the regime’s response to them could embolden U.S. President Donald Trump to refuse to certify the Iran nuclear deal and extend sanctions on Tehran’s energy industry, according to Helima Croft, global head of commodity strategy for RBC Capital Markets. President Trump faces several Iran-deal-related deadlines in coming weeks.

Struggling Venezuela is another OPEC member whose production could sharply fall, which could lead to the cartel agreeing that restricting supply is no longer appropriate in a market that is significantly tighter than before the cuts started. Related: Is This The Beginning Of An Oil Sands Revival?

According to a Bloomberg survey from last week, OPEC’s crude oil production remained largely unchanged from November in December, but that was mostly thanks to a 50,000-bpd decline in Venezuela’s production.

2. OPEC Members Cheating

Another way the cuts could end earlier is OPEC members repeating history and starting to cheat, with Iraq given as an example of a possible early dissenter. Iraq has been the least compliant producer, and in the few months in which it came close to its production ceiling, it was the fallout from the Kurdistan region’s referendum and federal army retaking Kirkuk oil fields that helped Iraq to largely stick to its quota, not its purposeful actions.

“As seasonal demand picks up in the summer months, we expect Iraq’s compliance with the agreement to slip,” analysts at BMI Research told Bloomberg.

3. ‘Mission Accomplished’

The third possible road to OPEC ending the deal early is (1.) market rebalancing around the middle of 2018, or (2.) Russia persuading its OPEC allies in the deal that the market is already tightened and there is no need to overtighten it and send oil prices too high and too comfortable for U.S. shale production growth. OPEC and non-OPEC producers are meeting in June to review the state of the oil market, and the impact of the cuts—a clause in the November 2017 deal extension included on Russia’s insistence.

Some bullish voices, like Goldman Sachs, see the oil market balanced at the end of Q2 2018. OPEC, however, currently expects excess global inventories to arrive “at a balanced market by late 2018.” OPEC doesn’t expect significant drawdowns in oil inventories in the first quarter of 2018, just like in 2017, Saudi Arabia’s Energy Minister Khalid al-Falih has said, and the message from OPEC is that we’ll have a clearer picture by June.

4. U.S. Shale Rising Too Much, Too Fast

The higher oil prices in a too-tight market could motivate U.S. shale producers to pump more than analysts currently predict. OPEC and allies are aware of the fact that U.S. production will grow, but if it grows too much, the cartel and Russia could ditch the pact and start defending their market share. This move, however, could send oil prices much lower than now—and OPEC would not be pleased. Related: China Is About To Shake Up Oil Futures

Oil prices are currently at levels at which U.S. production could substantially increase. According to the Q4 Dallas Fed Energy Survey published at end-December, 42 percent of executives at 132 oil and gas firms expect the U.S. oil rig count to substantially increase if WTI prices are between $61 and $65 a barrel. Another 31 percent of executives forecast that oil prices will need to be between $66 and $70 a barrel to see a substantial increase, while 20 percent think prices have to be above $70 for oil rig counts to substantially rise.

OPEC and the Russia-led alliance face a number of challenges in keeping their deal intact until the end of 2018. It’s still too early to tell how the market will behave and how geopolitical risks factor in.

By Tsvetana Paraskova for Oilprice.com

More Top Reads From Oilprice.com:

• Is An Oil Price Correction Overdue?
• Trump Proposes Most Aggressive Offshore Drilling Plan Ever
• Europe Becomes Victim of Russia’s Newest Oil Strategy