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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

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  • Johnny on January 08 2018 said:
    This topics and texts we read during all 2017 and looks like we'll read during 2018,maybe during 2019 also.Somebody will increase or somebody will cheat......Becoming boring.
    OPEC,NOPEC including US production have been heavily damaged due to low oil price since begining of decade and they very well know what increasing of reserves means.Do not forget that Aramco is preparing IPO,and Saudis and Russians are major players in production cut which suffered a lot due to low price.
    Second myth is possible dramatically increase of US shale production.How dramatically production can be increased from current which is 10 millions bbls per day?Increase to 12,13,14,15.... milion barrels?How much was invested during last few years in oil sector to support some dramatically increase?The truth is investment were on the minimum or not even in minimum.Even number of rigs is stabilized with one or two plus/minus per week.Last but not least world economy is doing well and need more energy for "warmed engines".
  • Mamdouh G Salameh on January 09 2018 said:
    Your article provides a very good insight into the global oil market. However, out of the four factors you outlined, only the “Mission Accomplished Factor” is valid in my opinion.

    Oil production in Venezuela and Iran is not going to collapse. As for Iran, even if the United States extends sanctions on it, this will not affect Iran’s oil production and exports. It will be regarded by Iran as a mere nuisance.

    As for OPEC members, they have not cheated when they were more in need of money so they are not going to start cheating now when their objectives are in sight. So I discard this factor.

    Projections about steep rising US shale oil production 2018 are no more than mere projections intended by the EIA to curb the rise in oil prices. The market has seen through that ploy. Any real increases in US shale oil production will no longer deter the rise of the oil prices in 2018.

    In conclusion, the “mission accomplished factor” is the most possible one. If the prices continue their advance and the global oil market shows definite signs of re-balancing, OPEC and Russia will review the situation in June this year and may decide to loosen the production cuts a bit or bring it to an earlier conclusion under pressure from both Russia and Iraq. My bet is that they will let the agreement expire by the end of this year in an orderly fashion.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Anonymous on January 09 2018 said:
    Inventory is irrelevant. That is a bunch of distraction to avoid saying what they are really doing--constraining supply to raise price. Like any good little cartel.

    They are not going to abandon the agreement because prices get too high (remember they were just fine with prices at $100). If prices rise higher, with them just doing that tiny 1.8 MM cut, fine. More payoff for the tiny cut! Why stop!

    If shale rises (and prices stay up), who cares. They are still getting what they want. And if they dump 1.8 MM bopd on the market, they will be back to $40 oil toot sweet. It's not worth the loss to their overall profits to cut out one free rider. Conversely if shale crashes the market, they may decide to go back to market share competition. But no danger of that now. Would only happen if prices start dwelling in lower 40s (and shale stays resilient there). Both doubtful to happen.

    If cheating breaks out, this is only a danger if prices drop (and/or SA is doing massive cuts, like in 1986). Neither is the case now. They will not upset the apple cart, given their little cut is probably propping prices up by $20 or more right now. Not worth it to squash Iraq (or some other cheater, Russia even) when things are going well. As long as the cheaters at least cheat secretly versus openly, that will be good enough, given how prices are doing and what would happen if they dumped the extra barrels back on the market.

    As far as demand growing, GREAT. That makes it easier to gouge the market.

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