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OPEC+ Top Priority: Don’t Crash Oil Prices

OPEC+ is considering increasing production in the second half of 2019, as the oil market tightens following a series of major outages.

OPEC+ met in Jeddah over the weekend to assess the state of the oil market and discuss the group’s plans for the rest of the year. The technical meeting comes ahead of the highly-anticipated June meeting in Vienna, where the coalition is expected to finalize its plans. 

In Jeddah, however, OPEC and its partners examined a few scenarios. Saudi Arabia and others within OPEC reportedly want to keep the cuts in place while Russia is more eager to loosen the curtailments.

According to Reuters, Saudi Arabia and Russia are mulling two options, both of which consist of higher output. The first option would consist of reducing the agreed upon cuts of 1.2 million barrels per day (mb/d) to just 0.9 mb/d going forward.

The second option would call for ending over-compliance with the 1.2-mb/d curtailment. Saudi Arabia’s deeper than required cuts and the (involuntary) outages in Iran and Venezuela would be compensated for with more barrels from elsewhere. This plan would roughly translate into a production increase of 0.8 mb/d.

But while the second option could lead to more supply on the market, it would still officially maintain the 1.2-mb/d level, which OPEC is loath to change. Top officials from the Gulf States have balked at the proposal to lower the headline cut from 1.2 to 0.9 mb/d. “I don’t think easing the cuts is a good option,” said Emirati energy minister Suhail al-Mazroui, according to the Wall Street Journal. They’d rather just bring over-compliance back into alignment.

Related: The Single Most Bullish Indicator For Oil

When you think about it for a second, the differences of opinion between Russia and Saudi Arabia are logical. The Saudi preference would be to roll over the cuts, but if it had to agree to a change, it would prefer the plan that calls for reducing the over-compliance. That makes sense since Saudi Arabia is the one over-complying; agreeing to this option would allow the Saudis to enjoy the benefit of increasing production. Russia, instead, wants the overall cuts to be lowered from 1.2 mb/d to 0.9 mb/d, which would presumably offer more room for them to hike output.

To be sure, however, the group has not agreed on anything just yet. The obvious thing to do at this point is to simply wait for another month before taking action. “It is critical that we don’t make hasty decisions – given the conflicting data, the complexity involved, and the evolving situation,” al-Falih said. The oil market outlook is “quite foggy,” given the weakening demand picture but the threats to supply.

Oil prices have rose by more than 30 percent this year, evidence that the cuts have succeeded in tightening the market. But there are two elephants in the room: Supply outages and the potential for an economic downturn.

U.S. sanctions on Iran and Venezuela have led to severe disruptions in those countries, and military conflict is not out of the question. The potential for a price spike is real.

However, the U.S.-China trade war could magnify the economic deceleration that was already underway. Speculators have grown more bearish, selling off net-long positions in the most recent data release, a sign of growing pessimism around the global economy.

Oil is being pulled in both directions.

Meanwhile, some of the data is confusing. Inventories have narrowed sharply, but haven’t moved much in recent months. And in the U.S., inventories have actually increased. This data clearly worries the Gulf States, who fear another price collapse if they agree to increase production.

Related: On The Cusp Of War: Why Iran Won’t Fold

Yet, other indicators are more bullish. The Brent futures curve is in a rather steep state of backwardation, while the physical market seems tight with certain benchmarks rising amid supply tightness. “We have now reached the stage where crude differentials globally and across all slates are strong,’’ Greg Newman, co-CEO of Onyx Commodities, told Bloomberg last week. “There is only one conclusion: the prompt market is short of oil. With the current situation, the outright price should continue to strengthen until demand suffers.”

Saudi oil minister Khalid al-Falih told reporters that there is more work to be done. “This second half, our preference is to maintain production management to keep inventories on their way declining gradually, softly but certainly declining towards normal levels,” he told reporters. He said that Saudi Arabia “isn’t fooled” by oil prices at $70 per barrel. He still sees weakness in the market.

Even Russia seemed to suggest that production increases were contingent on strong demand. “Today, we are looking at various options [for the second half of 2019] including softening the production levels,” Russia’s energy minister Alexander Novak told reporters. “If there is a growth in demand, we are ready to consider and mitigate those parameters, a partial recovery of production,” he said.

The upshot is that while OPEC+ is considering a few options to increase production in the second half of 2019, the group will be much more hesitant to do so over fears of a rerun of 2018 when prices crashed.

By Nick Cunningham of Oilprice.com

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