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Why OPEC Didn’t Intervene In Oil Markets

Brent jumped above $80 per barrel on Monday, coming on the heels of the decision by the OPEC+ coalition to do nothing in the face of the tightening oil market.

The meeting in Algiers between OPEC and the non-OPEC partners ended with no decision to increase oil production beyond what was agreed to in June. The Joint OPEC-non-OPEC Ministerial Monitoring Committee (JMMC) “noted that, despite growing uncertainties surrounding market fundamentals, including the economy, demand and supply…the Committee expressed its satisfaction regarding the current oil market outlook, with an overall healthy balance between supply and demand,” OPEC said in a statement.

The group merely reaffirmed its goal of achieving 100 percent compliance with the production cut deal, noting that compliance stood at 129 percent in August. “The markets are adequately supplied. I don’t know of any refiner in the world who is looking for oil and is not able to get it,” Saudi Energy Minister Khalid Al-Falih told reporters after the meeting.

But of course, the compliance rate in excess of 100 percent is the result of enormous supply losses from Iran, not to mention ongoing declines in Venezuela. Estimates continue to offer a wide range on the potential outages from Iran as November sanctions approach, but they run from 1 million barrels per day (mb/d) to 2 mb/d. Only a few months ago the consensus estimate of Iran losses seemed to hover around 0.5 mb/d.

These supply losses are significantly tightening the oil market, pushing prices up to their highest level in more than two months.

“This is the oil market’s response to the “OPEC+” group’s refusal to step up its oil production,” Commerzbank wrote in a note, referring to Brent rising above $80 per barrel. “US President Trump had indirectly demanded this in a tweet he sent a few days before yesterday’s informal meeting between OPEC and those non-OPEC countries taking part in the production cuts. Instead, ‘OPEC+’ is still keen to maintain 100% compliance with the cuts.” Related: New Breakthrough Could Lead To Safer Energy Storage

According to RBC Capital Markets, the recent terror attack in Iran could matter more for the oil markets than the OPEC+ meeting if it stokes broader regional conflict.

But that remains speculative. For now, the oil supply/demand balances will continue to drive oil prices, and for the next few months at least, the trend appears bullish. Major oil trading houses have suggested that prices could spike to $100 per barrel as the balances tighten.

Still, Saudi Arabia said it plans on increasing output this month, followed by another increase in October, although details on the specifics are lacking.

The oil market is clearly concerned that OPEC+ could be late to respond. Saudi Arabia has promised to offer higher output if the market demands it, but so much market data is only published on a lag. It’s as if al-Falih is driving the ship but only looking through the rear-view mirror.

A broader concern is that Saudi Arabia’s spare capacity is really untested. Riyadh insists spare capacity stands at around 1.5 mb/d, but that is unproven. Also, producing at an elevated level on a sustained basis – beyond 10.6 mb/d, which is pretty much where they are at now – is also untried. Related: Saudis Expand Mining Sector As Part Of Diversification Push

Moreover, even if Saudi Arabia can demonstrate an ability to produce at 11 mb/d or more for a sustained period of time, it will only come at the expense of spare capacity. Leaving the market thin on surplus production capacity, even if it results in more barrels put onto the market, is risky. A subsequent outage would present serious problems to global supplies.

There are also pricing impacts to cutting spare capacity, even before another outage occurs. In other words, oil traders might be pleased to see more supply put onto the market in the next few months, especially as Iranian production goes offline, but dwindling spare capacity could also provoke more volatility.

It’s a balancing act with no clear answers. For now, Saudi Arabia wants to withhold its firepower and assess the impact of U.S. sanctions on Iran. That means that in the immediate near-term, the oil market will tighten.

By Nick Cunningham of Oilprice.com

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