OPEC's looming taper tantrum: Fuel for Thought

Choking back the flow of crude to boost prices was an easy decision for OPEC and Russia to make last year when inaction would have almost certainly led to economic oblivion. After Brent closed Friday above $60/b—its highest level in two years—deciding how and when to reopen their spigots without causing the oil market’s equivalent of a taper tantrum looks much harder to achieve.

OPEC-led production cuts rebalancing market, analyst says

The stakes couldn’t be higher for the 14 countries in OPEC and their 10 oily allies led by Russia. Get it wrong by extending their cooperation deal for too long beyond its March 2018 expiry and the nascent revival of US shale could undermine their hard work rebalancing the market. Crude inventories in industrialized countries are falling but painfully slowly.

Despite record compliance with cuts and multilateral collaboration, commercial stockpiles in the OECD have dropped just 3% since January to a smidgen under 3 billion barrels in August, according to OPEC data. That’s still some 171 million barrels above the five-year average that the coalition is targeting. The signals on demand are equally muddled. OPEC has nudged up its global demand forecast for 2018 to 96.8 million b/d but on the whole growth looks anemic.

Meanwhile, US producers have made the most of higher prices and fewer OPEC shipments to increase their own output and exports. Total US production had climbed to 9.2 million b/d in July, adding over 360,000 b/d since the November 2016 output deal agreed between OPEC and primarily Russia, according to Energy Information Administration data. More worrying for OPEC, exports of crude from the world’s largest consumer were up a third to almost 900,000 b/d over the same period.

Understandably, monitoring the pace of recovery in the US oil patch is now probably the biggest factor weighing on the minds of OPEC policymakers ahead of their final gathering of the year next month, say some experts. In Vienna, officials are expected to agree to an extension to the existing pact with Russia and other producers outside the group—which has already sucked around 1.8 million b/d from supply. The length of that roll-over to the existing deal is what’s still open for debate.

“The oil market is very difficult to read at the moment so I don’t think OPEC will be in a hurry to release the current agreement below a price of $60,” said Abdullah bin Hamad al-Attiyah, Qatar’s former energy minister and OPEC president, in a telephone interview from Doha. “OPEC is now playing what I like to call a cat and mouse game with shale. They will have to watch the US very closely to see how many rigs are coming back before making any decisions.”

Although the latest count of US onshore rigs by Baker Hughes showed a slight decline earlier this month there are still almost 300 more units operating than a year ago. The chances of that rebound in activity continuing into 2018 will be boosted if OPEC and Russia can continue to restrict their own supplies for a further year. How they unwind that agreement without causing the oil market equivalent of a temper tantrum could be equally difficult to figure out. The last time exiting the deal was mentioned in May by Saudi oil minister Khalid al-Falih the market freaked out.

Without agreement on a plan to drip crude back into the market Russia and Saudi Arabia —the world’s top two producers — would quickly be racing each other to pump every last barrel. Russia’s energy minister Alexander Novak said last week that his country could produce another 80,000 b/d immediately next year if there is no deal in Vienna. Those volumes would certainly increase if Saudi Arabia responded by increasing its flows, triggering a renewed race for market share.

That’s unlikely ahead of the kingdom’s planned IPO in 2018 of state-owned Saudi Aramco. The sale of a 5% stake in the world’s largest single producer of hydrocarbons requires prices closer to $80/b to come close to the desired $2 trillion valuation that Crown Prince Muhammad bin Salman has demanded.

The prince—who overseas economic policy including oil—also needs higher prices to help fund economic development plans for the kingdom known as Vision 2030.

The lure of higher prices could also tempt some producers to loosen up on compliance. From January through to September—when Brent crude averaged $51 per barrel— adherence to targets amongst the 12 countries with quotas has been around 106%, according to the S&P Global Platts OPEC survey. Such discipline isn’t expected to last.

“Some countries become more relaxed when they see the price going up,” said Attiyah.

Provided that Saudi Arabia is willing to continue doing the majority of OPEC’s heavy lifting then a replay of the damaging price war which started in 2015 should be avoided.

What is less assured is the continued commitment to a ceasefire of other major producers. Iraq and Iran maintain plans to scale up production over the next decade, while the kingdom’s dispute with Qatar has blown apart unity amongst the Gulf Cooperation Council, which has traditionally formed a powerful bloc within OPEC.

If striking its historic cooperation pact with Russia was tough, OPEC’s task of tapering the deal looks much harder.