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Is It Time For OPEC To Turn The Taps Back On?

OPEC

Russia’s Energy Minister Alexander Novak said earlier this week that he’d spoken with his Saudi counterpart about the possibility of another extension to the OPEC-non-OPEC crude oil production deal; oil prices rose. Industry observers once again reminded us that there aren’t any new options for OPEC and its partners: they can either keep on cutting and lose market share, or they can turn the taps back on and bring prices down.

Bloomberg Gadfly’s Liam Denning argues that the second scenario is the only one that could work for low-cost producers such as Saudi Arabia. Enough with the comments about a new extension, Denning suggests, nobody is listening. A U-turn in Saudi oil policy, according to him, is the only way to survive. Yet there is a catch in Denning’s scenario.

He says, The rational thing to do would be for large, low-cost producers such as Saudi Arabia to maximize output and drive oil prices down to a level that both stops the flow of capital into U.S. fracking and spurs demand for more barrels.”

That’s dreamland for any low-cost oil producer, but how do you find it? Oil demand forecasts from the International Energy Agency and the Energy Information Administration alike don’t see a lot of support for a sharp growth in demand. On the contrary – as Denning himself notes, the factors that will slow oil demand growth further are growing, chief among them the switch to electric vehicles.

Related: China Declares Support For Punitive Action Against North Korea

It may be true that experts are no longer paying much attention to what this or that energy minister from the Vienna Group says about deal extensions. Media do, however, and diligently report on every such comment despite the fact that the discussion Novak was referring to in his latest remark took place in July and can hardly be considered news. The Russian minister has, since the start of negotiations of the cut, said that all options are on the table. They still are, is what he said this week. No surprises.

But Russia and Saudi Arabia were pushing for this second extension, the Wall Street Journal reported late last month, citing unnamed sources familiar with the discussion. Russia seems to be feeling jut fine with current oil prices. Customs data this week showed that revenues from crude oil exports had jumped by 35 percent over the first seven months of the year. Novak said the current price level of Brent, at US$54 a barrel, is “optimal”, allowing the industry to make investments in new production while keeping prices at the pump affordable.

Meanwhile, Saudi Arabia is revising its Vision 2030, as it turns out the initial goals set in the program were a bit too ambitious. The Kingdom is also preparing for the listing of Aramco, which could literally make or break Vision 2030. The program is costly and Saudi Arabia has a budget deficit to deal with besides the long-term diversification.

There’s hardly any doubt that Saudi Arabia and Russia are the leaders of the pack when it comes to the cut deal. They’ve been forging closer ties in recent months, and not only in energy. Yet they don’t exactly want the same thing when it comes to oil. Russia is a higher-cost producer than Saudi Arabia, so it will have more trouble if prices fall sharply. On the other hand, Saudi Arabia is more heavily reliant on oil revenues for its budget than Russia— any oil revenues—not to mention that Riyadh has cut more of its output than Moscow.

Related: Expert Commentary: Oil Market Tighter After Hurricane Harvey

A projection from energy economist Phil Verleger, as quoted by Denning, sees low-cost OPEC producers—Saudi Arabia, Iraq, Kuwait, Qatar, and Iran—losing 9 percentage points from their market share if the artificial propping up of prices continues until 2022. Russia’s share under this scenario will remain virtually unchanged, and that of the United States and other non-OPEC producers will rise.

Turning the taps back on indeed starts to look like the only thing left to do, as long as those turning them are ready to bear the consequences, which could include bankruptcies (think Venezuela), unrest at home, and the breakup of OPEC, most likely. This last one, if it happens, means other deals to control the supply of the world’s most popular commodity will become a lot harder to reach should the need arise.

By Irina Slav for Oilprice.com

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  • D on September 10 2017 said:
    turn the taps back on for what? the US is trying to keep the price down, yet the US national inventory has been dropping since the beginning of this year. The loss from the US shale made up for the benefit from lower oil price in the US imports, however, that won't last. The US shale loss would be too large (higher marginal cost to produce more) to make up for the whole OPEC cut now.
  • Drsaad786 on September 10 2017 said:
    Wishful thinking of the author. Oil market is tightening. Shale 2.0 boom is reversing. These headlines are put only for the algos to become more bearish. Shale output has already peaked. Harvey has permenantly reduced shale output. When algos are taken over by real buyers, oil price will skyrocket and OPEC NOPEC will get the fruits of cutting output.
  • Gavin J on September 11 2017 said:
    Talk of electric vehicle sales are overblown. Sales are poor at best. EV vehicles only appeal to affluent people in the sunshine belt of the US. Even Norwegians are not embracing EV's, despite government subsidies of up to 30% of the cost of the vehicle! And the fact is that most EV's run on fossil fuels, which is what powers Florida (Coal 25% Nat Gas 62%) and California (Nat Gas 45% Coal 10% Unspecified i.e. imported Coal/Natural Gas 30%). EV's owners are deluded to think they are reducing emissions. EV's have a larger full-cycle carbon footprint than conventional cars. Gasoline powered vehicle sales are surging in China, India and other developing economies.
  • Chad Schieck on September 11 2017 said:
    Not going to happen. This is propaganda.

    OPEC (mainly KSA) can not cut their throats any further ESPECIALLY with the dream of the aforementioned Vison2030 PSA of Aramaco.

    OPEC is simply going to limp along and bleed out a very slow and very painful death. They really need to read about the stages of grief. The author seems to be in stage one (denial) while the KSA is in stage three (bargaining).

    OPEC is terminally ill. They can turn on the taps (pull the plug Dr Kavorkian style) and try to start over in a couple of years OR they can slowly bleed out and try to start over in a decade or two. Either way, they are dead and their people will suffer immensely (not that the KSA cares).
  • Disgruntled on September 13 2017 said:
    OPEC is dead? Fyi, OPEC cut their production to about 28 mmbopd back during the 2008-09 Great Recession in order to support price recovery. They can run that play again anytime they want. They, for whatever reason, just don't want to. Personally, I think the "war on shale" continues, and they are simply trying to reinforce demand. Note that the IEA just increased the estimate for 2017 demand increase to 1.6 mmbopd. People just can't get enough of cheap energy.

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