The surge of Brent crude prices over the last few weeks to $70 may be rattling OPEC, raising questions about the longevity of the collective production cuts.
Top OPEC officials surely did not expect such a dramatic run up in prices, at least not this early in the year. Both OPEC and the IEA have forecasted a rebound in crude storage levels in the first half of this year, a trend that was thought to keep a lid on any price rally. The working assumption was that oil prices wouldn’t dramatically improve until mid-2018.
Against that backdrop, OPEC officials didn’t think they would have to answer too many questions about the group’s plan until its June meeting. But with Brent at $70, the market is watching for clues about OPEC’s resolve — and some tiny cracks appear to be forming.
Russia’s energy minister said last week that OPEC and the non-OPEC coalition would begin discussing the possibility of a “smooth exit” from the production cuts, according to Reuters. Russian energy minister Alexander Novak also tried to tamp down concerns about prices rising too much too fast, arguing that the rally was likely temporary. “We see that the market is becoming balanced. We see that the market surplus is decreasing, but the market is not completely balanced yet,” he told reporters. “Of course, we need to continue monitoring the situation.”
The chief of Russian oil company Lukoil said last week that Russia should exit the deal if oil prices remain at $70 per barrel for more than six months. Related: Strong Oil Demand Growth Supports Oil At $70
Meanwhile, Iran’s oil minister recently admitted that OPEC does not want oil prices above $60 per barrel.
Although there is little chance of any change in course anytime soon, OPEC officials will be compelled to discuss the state of the market at their upcoming monitoring meeting in Oman on January 21.
Other top oil ministers recently went public to shore up the group’s resolve, or at least to reassure the oil market that the group’s cohesion was not under strain from high oil prices.
UAE’s energy minister told CNBC last week that although prices have climbed quickly, there is still more work to do. "I am expecting that we will still see corrections in 2018 and I think it's the year of... the market fully achieving the balance," he said.
Qatar’s energy minister told its state news outlet, according to Bloomberg, that OPEC shouldn’t review the accord until global inventories come back down to the five-year average, the metric upon which OPEC is basing its production cuts.
Iraq’s oil minister also sought to reassure the market about OPEC’s resolve. “There are some sources here and there indicating that the market is flourishing now, the prices are healthy, so let’s talk about terminating the freeze,” oil minister Jabbar al-Luaibi said at a conference in Abu Dhabi. “This is the wrong judgment, and we don’t agree with such a concept.” The support of OPEC’s second largest oil producer is notable.
“We hope the whole dynamic will continue throughout 2018,” al-Luaibi added. “The deal should continue. The market now is stabilizing somehow but it’s not yet stable.”
Oman — not an OPEC member but a party to the agreement — echoed these comments in a Bloomberg interview. “It’s absolutely crazy, for all of us, to increase production by 10 percent and to lose revenue by 40 percent, and this is what we did in 2014,” Oman oil minister Mohammed Al Rumhy said.
Based on all of the recent statements from key oil ministers party to the OPEC deal, there doesn’t seem to be any daylight between them – OPEC will stay the course until the market becomes balanced.
But that could come a lot sooner than the group thought if current trends continue. JP Morgan said in a recent research note that OPEC was “very likely to cut short” its deal if the market balances before the end of the year.
Still, there are reasons why OPEC shouldn’t rush to judgement and hop off of the market management train too soon. A lot of speculative money is helping to push prices up. If investors unwind those bullish bets, prices could quickly come back down.
Also, the definition of the “five-year average” for oil inventories is a moving target, one that sort of waters down the meaning of declining inventories. Because the range in that five-year timeframe increasingly encompasses a period of time of elevated inventories, the target that OPEC is aiming for is moving closer. In other words, at the same time that real world inventories are declining, the “five-year average” target is rising.
The upshot is that what is considered average is a lot higher than it used to be. That means OPEC doesn’t necessarily need to panic that it is overshooting and tightening too much.
But the one factor that is probably rattling OPEC more than anything is the prospect of another wave of U.S. shale supply. Expectations of growing U.S. shale production have risen recently, with an aggressive growth scenario laid out by the EIA last week. Also, the head of the IEA said last week that oil prices between $65 and $70 per barrel risks oversupply from U.S. shale.
On top of that, if shale drillers use the recent rally to lock in hedges for 2019 and beyond, they could ensure the supply gains keep coming, regardless of a price correction. Some view that as a reason for OPEC to keep the production cuts in place — the group won’t overshoot because there is plenty of supply coming.
But, as the comments from Iran’s oil minister illustrate, some within OPEC are getting worried that the production cuts themselves are sparking too much shale supply. That raises the odds of faltering compliance this year.
By Nick Cunningham of Oilprice.com
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