OPEC-plus: Old strategies, new manifesto - Fuel for Thought

OPEC’s ability to balance the market has many naysayers amid stubborn stockpiles, rising US production and the same old tactics of output quotas that typically sooner than later fall apart.

But this producer pact is a very different phenomenon: one that doesn’t just have non-OPEC countries on board, but has organized joint monitoring committees to fully track compliance with production cuts and a strong collective communication (including regular technical meetings and ministerial dialogues).

This has fostered a sense of togetherness among oil producers that usually are more interested in competing for market share.

As a result, this new producer alliance could be here for the long haul.

OPEC is on the cusp of overcoming one of its biggest challenges: convincing a skeptical, and often myopic, market that it has changed.

The overplayed narrative of OPEC versus US shale has distracted market watchers from where the real overproduction has stemmed from: OPEC itself. OPEC, led by Saudi Arabia, flooded the market with an additional four million b/d of crude with its pump at will strategy after November 2014, according to the S&P Global Platts survey.

Since this approach led prices to crash, OPEC reversed course, and in November 2016 instituted its landmark deal to curb output by 1.2 million b/d, along with an extra 558,000b/d removed from non-OPEC output. OPEC had realized that trying to kill off shale was not only futile but that it had unleashed a glut of its own making.

Whatever OPEC skeptics tell us about stubbornly low prices, consider where prices would be without the deal. That OPEC put its production genie back in the bottle was always going to require patience from the market, something it has no inclination for, and explains the split between analysts’ expectations for market rebalancing later this year and the burden of inventories off which market players were trading.

‘OPEC-plus’ has been a subtle and important departure from past practices of the organization. The impact of having non-OPEC countries sitting round the Vienna HQ table, including Russia, cannot be overstated as those countries together accounted for more than half the world’s production as opposed to roughly a third with only OPEC.

Another important difference this time around is the use of a joint OPEC/non-OPEC monitoring committee that looks at independent verifiable secondary sources, of which S&P Global Platts is one, to measure and monitor adherence to the agreement. The increased transparency through organized committees has made it easier for participants to see who’s sticking to the deal (over 100% compliance according to Platts) and allows non-OPEC to follow in a way that wasn’t possible before.

Rebranding OPEC

Despite the success of coordinating a multinational agreement, it’s been difficult for OPEC to shake off its pejorative image, especially when that image suits a market that doesn’t want to be managed. Variations on a theme of OPEC as a cartel and of production cheating market meddlers are common phrases among journalists, analysts and traders. There’s even an old joke among analysts: why is OPEC like a teabag? Because it only starts working when it is in hot water.

But OPEC not only got going, it went through a transformation when prices went below $30/b and set off a chain of events led by the doyen of diplomacy OPEC Secretary General Mohammed Barkindo. Most of the oil ministers who were present in November 2014 are now gone. But with Barkindo and Saudi Arabia’s Khalid al-Falih stewarding a year-long public relations drive and courting allies to pull off a global deal the UN or any major oil company would be envious of, oil prices quickly regained $20/b.

At each opportunity Barkindo reminds the market of the historic nature of the deal. He understands the importance of market psychology and the power of the rebalancing narrative, something that has wobbled of late, despite the oil alliance backing at least a nine-month extension rather than a previous six months rollover.

The glass half empty crowd also misinterpreted OPEC’s lack of announcement around an exit strategy and it has taken a concerted effort by Saudi Arabia, Russia and Barkindo since to suggest the OPEC/non-OPEC pact will be “institutionalized,” and Barkindo suggesting in Moscow it was like a “Catholic marriage” with ”no divorce.”

OPEC-plus has given itself some time to consider what the post-deal alliance will look like and will have to answer the question on what structures need to be in place for OPEC-plus to remain.

In the meantime, OPEC-plus must be patient as the market adjusts to the group’s new manifesto, which acknowledges that in order to manage the market their needs to be greater communication, transparency and unity. If that recipe is continued to be followed then a backwardated market won’t be far behind and the old-style managed market could become the new normal.