London/Moscow — Expect no immediate change of course from Saudi Arabia, Russia and their allies in a production cut agreement, as they test consumers' tolerance for higher oil prices.
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With the US' withdrawal from the Iran nuclear deal expected to have a muted impact in the short-term to the physical oil market, the Saudi/Russian-led OPEC/non-OPEC coalition may see no need to urgently tap spare capacity to replace any shut-in Iranian barrels.
Related feature -- Iran Sanctions: Global Energy Implications
But if the US sanctions on Iran's oil sector persist and Venezuela also sees the hammer of additional US sanctions in the coming weeks, the producer group may have to ease up on its cuts or risk overtightening the market as the summer peak demand season looms.
"I don't expect anything much to change [to the OPEC/non-OPEC deal] in the short term," said Mazen al-Sudairi, head of research for Saudi-based Al-Rajhi Capital. "In the long term, if Iran is unable to increase production, it would be beneficial for the OPEC and Russian alliance to reallocate the quotas."
Buyers of Iranian oil have until November 4 to wind down their purchases before US sanctions kick back in.
Most analysts surveyed by S&P Global Platts expect an immediate impact of less than 200,000 b/d of Iranian crude shut in, rising to perhaps 500,000 b/d after six months as the deadline nears. But some say the disruption could be closer to 1 million b/d.
Venezuelan output, already in freefall, could be hit further if the US institutes sanctions in response to Venezuela's upcoming May 20 presidential election that it has criticized as fraudulent.
A source in Venezuela's oil ministry told Platts on condition of anonymity last week that the government was preparing for a "worst-case scenario" of a 200,000 b/d output drop by December -- although some experts say the fall could be steeper.
OPEC next meets June 22 in Vienna to decide on its oil production policy, followed the next day by a meeting with its non-OPEC partners.
The production cut agreement, which commits the 24 participants to 1.8 million b/d in supply cuts, is scheduled to run through the end of 2018.
RIGHT PRICES, RIGHT TIME
Some of those missing Iranian and Venezuelan barrels will undoubtedly be filled by US shale producers who will take advantage of higher prices in a tighter market to drill.
But in the event of a major market squeeze, Saudi Arabia and some of its Gulf allies in OPEC may very well have to step in, spelling a potential end to the production cut agreement.
"The kingdom would work with major producers within and outside OPEC, as well as major consumers, to mitigate the impact of any potential supply shortages," the Saudi Press Agency quoted an unnamed energy ministry official as saying late Tuesday.
Saudi Arabia, OPEC's largest producer by far, holds some 2.18 million b/d of spare capacity, the International Energy Agency estimates.
But Saudi energy minister Khalid al-Falih said last month he had seen no impact to demand from the recent market run-up, and the country's ambitious structural reforms under Crown Prince Mohammad bin Salman's signature Vision 2030 program may demand even loftier crude prices, suggesting a status quo on the production cuts for the time being.
The International Monetary Fund last week estimated Saudi Arabia's fiscal breakeven oil price at near $88/b, and MBS himself has said the hyped public listing of state oil company Aramco that will fund many of the Vision 2030 reforms is awaiting a higher price environment.
"We believe oil prices will get higher in this year and also get higher in 2019, so we are trying to pick the right time" for the IPO, the crown prince told Time magazine last month.
But Saudi sources have told Platts the country is not blind to the risks of overheating the market.
"Although the kingdom prefers high oil prices ahead of the Aramco IPO and because of their tight budget, they are also well aware of the demand destruction higher prices would bring," said Tamas Varga, an analyst with brokerage PVM Oil Associates.
Other OPEC members holding spare capacity, according to the IEA, include the UAE (310,000 b/d), Iraq (310,000 b/d) and Kuwait (240,000 b/d). In all, the IEA estimates that OPEC has some 3.41 million b/d in spare capacity, defined as production that can be tapped within 90 days "and sustained for an extended period."
The US Energy Information Administration, which defines spare capacity more tightly, is less sanguine about OPEC's surplus capacity, estimating it at 1.94 million b/d, all within the Middle East.
As for Russia, the major non-OPEC participant in the deal, Moscow-based ATON analyst Alexander Kornilov said he expects the country could boost its production by about 100,000-150,000 b/d in about a month.
The IEA estimated that Russia earned an extra $121 million/day in revenue in the first quarter of 2018 due to higher prices.
"I think Russia will just be really happy seeing oil prices above $80/b," Kornilov said. "Perhaps down the road in order to ease that deficit situation, the OPEC+ deal members might decide to alleviate somehow the cuts in their production, but we'll see."