Oil prices plunged on Friday after news broke that OPEC and its partners, including Russia, are considering allowing higher levels of oil production, which could mark the beginning of the end for the OPEC deal.
With inventories back at average levels, potential outages in Iran and oil production in Venezuela falling fast, OPEC could be forced into action after repeatedly promising that the production limits would be kept in place through the end of the year.
“We will ensure that the market remains in its trajectory towards rebalancing, but at the same time we will not over-correct,” Saudi oil minister Khalid al-Falih said, according to Bloomberg. The comments are notably different from just a few weeks ago when al-Falih dismissed concerns about higher oil prices.
The exact details still need to be finalized, but the outlines of a potential change are visible.
The losses from Venezuela mean that the country is producing more than 500,000 bpd below its agreed target, and output is expected to continue to fall at a catastrophic rate. Angola is also producing around 150,000 bpd below its target because of aging fields.
That means that the OPEC/non-OPEC alliance on the whole has achieved a more than 150-percent compliance rate as of last month. Another way of saying the same thing is that the group is under-producing.
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A “relaxing” of the cuts could mean the addition of 800,000 bpd to 1 million barrels per day back into the market, which would put the compliance rate back close to 100 percent.
Or the allowed increases could be much less. A more modest tweak would be to press for individual countries to produce up to their current targets, which effectively would mean Saudi Arabia adding around 300,000 bpd back into the market. Either way, Saudi Arabia and Russia are keen to keep the architecture of the agreement in place.
But again, the details still need to be worked out. According to the Wall Street Journal and Bloomberg, the Saudis want the more modest option while the Russians are pressing for stronger increases. As for timing, the increase in output could begin as soon as the third quarter.
However, a new agreement is easier said than done.
Increasing supply would mean that the portion of output that Venezuela is not using would need to be re-allocated to other members. However, agreeing on the specifics was a Herculean task the first time around.
There are a few issues that could complicate the negotiating process. A lot of OPEC members are already producing as much as possible and would have little scope to increase output. “Only a few members have the capability to increase production, so implementation will be complicated,” an OPEC source told Reuters.
Also, if, say, Russia and Saudi Arabia are granted more leeway to increase output, it would presumably come at the expense of countries with declining output: Angola, Venezuela, and presumably Iran. Iran’s output has not declined yet, but U.S. sanctions are widely expected to cut into exports. When all is said and done, Saudi Arabia will be effectively taking market share from Iran, adding another source of conflict between the two arch enemies.
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Moreover, any change to the specifics, some OPEC officials fear, could upset what has been a strong display of cohesion to date. “There is definitely a fear among Gulf countries that the situation could get out of control. We need to think realistically about how to cope with new changes if needed to,” a Gulf OPEC official told the Wall Street Journal.
The cuts have been in place for about 18 months, but fears of shortages have started to put pressure on OPEC. Interestingly, OPEC’s Secretary-General Mohammad Barkindo said that a critical tweet from President Trump in April sparked talks of changes to the output limits. China has also reportedly put some pressure on Saudi Arabia because of high oil prices.
Some within OPEC itself are wary of letting price go too high. Doing so stokes production growth from U.S. shale. Plus, oil prices surpassing $80 per barrel – and potentially moving up towards $100 – would start to cut into demand growth, which some oil-producing countries feel would be self-defeating.
The negotiations will continue behind closed doors in the lead up to the Vienna meeting on June 22.
By Nick Cunningham of Oilprice.com
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With all due respects to the author, I like to ask: When oil price was sky higher in the past, did any oil producer ever make any attempt to bring the price down in order not to cut into the demand? None. So, why does the author thinks those producers would rather wish lower price and worry about demand destruction because of higher oil price this time around?If that is the case, oil price will be a lot less volatile.