OPEC needs a clear line on oil prices: Fuel for Thought

OPEC would benefit from more transparency about oil prices. The group has geared its efforts to rebalancing the market, but its ultimate goal is surely to maximize revenues for its members. Putting a number on this target would be helpful.

After all, with many ministers claiming there is still a distance to go when the alliance has pretty much realized its stated aim, the focus on fundamentals is starting to look like a fig leaf.

OPEC and Russia, joined by a group of smaller producers, have focused on bringing bloated oil inventory levels in OECD countries down to the five-year average. With overcompliance to the deal, they have reduced their collective output by more than the agreed 1.8 million b/d since January 2017 and cleared an overhang of almost 400 million barrels in an unprecedented move.

Prices have skyrocketed 33% to well above $70/b in that time, raising two key questions: **At what point do prices destroy currently healthy demand? **At what point does a new wave of production, from US shale to deepwater, ease fears of a supply shock after several years of underinvestment?

Analysts themselves have yet to reach a consensus.

THE PRICE OF SETTING PRICES

The clear line from OPEC has become fuzzy. Many of the ministers suggest they are unconcerned about the recent rise in oil prices and its effect on consumption, stressing that they would not be deterred in their desire to see production cuts extended beyond end-2018 when the deal ends.

They welcome the surge in US shale production given that it acts as a sticking plaster to patch over the suture of a potential supply shortfall. OPEC has also insisted that the focus is on fundamentals of supply and demand, not on targeting price.

Doth the alliance protest too much? Maybe so. But then again, fixing and admitting a potentially moving price target is fraught with difficulties.

For starters, each country's costs to unearth oil are different and their motivations and dependencies on crude and refining also vary.

Take rivals and OPEC heavyweights Iran and Saudi Arabia, already at loggerheads in a proxy war in Yemen, and their spat over oil prices.

"If the current oil price hike trend continues, there will be no necessity for extension of the OPEC agreement," Iran's oil minister Bijan Zanganeh said a few days ago in direct contrast to his Saudi counterpart Khalid al-Falih.

A price target also exposes OPEC to charges from the international community that it is a cartel.

World leaders have bristled at the prospect of $100 oil again as risks emerge around inflation and higher interest rates. Indian Prime Minister Narendra Modi has been calling for "responsible pricing" for some time, while US President Donald Trump took to Twitter to accuse OPEC of artificially inflating prices.

Admitting to a price band puts pressure on the 24-country pact to deliver on a goal that is driven by more than fundamentals.

Falih was adamant at the monitoring committee meeting in April that "the market determines the price." While the broader OPEC alliance means it may have regained some leverage by taking almost 50% share of supply, it is keenly aware that geopolitical risk also shapes the market.

A RE-EMERGENCE?

At the Jeddah meeting, Falih made comments that indicated that price was a guiding principle and that there was an implied target.

"What we are trying to do is not move the prices to any unreasonable level," he said. By trying to assuage concerns over boom-and-bust oil, he admitted that Saudi Arabia at any rate has more than an eye on price levels.

Then again, jump-starting investment requires high and stable prices from an industry still licking its wounds from OPEC's 2014 pump-at-will strategy that sent prices tumbling.

The tentative signs are good, however, with oil majors starting to report healthy earnings results again and industry executives in in an upbeat mood.

"The deepwater looks very attractive in many places in the world, so I don't think it's either-or [shale or deepwater]," BP's CEO Bob Dudley said at an industry event this month. "Exploration is not over by any means there's still lots of exploration happening."

The comments, echoed by executives from France's Total, Italy's Eni and Spain's Repsol, come as spending on conventional oil and gas exploration and appraisal is estimated to have fallen by 60% since 2014.

Price targets are not alien to OPEC. The group introduced a band of $22-$28/b in the late 1990s following a slump, and it became a formal target between 2000 and 2004 before quietly being dropped.

In 2009, Saudi Arabia's King Abdullah called $75-$80/b a "fair price" and it became an unwritten price target for a while.

Could Saudi Arabia drive home a clear line on prices once again? Especially since the likely Saudi Aramco IPO and the need for a sizeable valuation that has become the backseat driver of OPEC policy.

While a price target could underpin OPEC's strategy in the long term, the producer pact is likely to keep up the charade given the difficulties.

This means finding a new measure that centers on fundamentals and allows the group to keep managing the market indefinitely, while allowing flexibility to loosen quotas if need be.