Vienna — For the first two months of the much-hyped OPEC/non-OPEC production deal, oil prices held relatively steady, as strong compliance with committed cuts, as least among OPEC members, kept bulls in the market.
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But as the year moved into March, trader sentiment began to wane, amid skepticism over the cuts' effectiveness at rebalancing the market and uncertainty about OPEC policy beyond the deal's June expiry.
Despite several OPEC members' confidence that the third quarter could see significant oil stock draws, fears of further price volatility seem to have prompted most, if not all, of the 24 deal participants to coalesce behind a proposal to extend the cuts for nine months at current levels.
That length, when the market had seemingly priced in a six-month extension, appears aimed at managing trader expectations and calming anxiety that OPEC could soon return to its free-wheeling pump-at-will strategy, analysts say.
"OPEC is in search of a sentiment surplus," said Joe McMonigle, an analyst with Hedgeye Potomac Research. "OPEC believes a nine-month extension into 2018 will provide it with a sentiment surplus and so far the market likes the move."
ICE Brent futures have risen by about $5/b since May 10 when US inventory data started turning constructive, followed shortly thereafter by declarations from Saudi Arabia and Russia, the world's two largest oil producers, that they would advocate for a continuation of the cuts through March 2018.
Appetite for a major row over the level of cuts appears low, and with oil inventories still stubbornly high, deal participants seem cognizant of the need for more time to let the cuts work.
The current deal calls for OPEC to cut 1.2 million b/d, and 11 non-OPEC producers, led by Russia, committed to 558,000 b/d in output reductions. Ministers will meet Thursday in Vienna to review the agreement.
While Ecuadorian oil minister Carlos Perez told reporters in Vienna on Tuesday that two proposals are on the table -- a six-month extension and a nine-month one, both at current quotas -- a five-country monitoring committee is set to formally recommend the nine-month extension, according to Kuwaiti minister Essam al-Marzouq.
Marzouq, however, added that all options would be considered, including deepening the cuts, as the producer bloc likely wants to keep the market on its toes heading into Thursday's meeting.
"Fighting over new quota levels would only undermine today's consensus, so why bother?" said Matt Reed, with the Washington-based Middle East consultancy Foreign Reports. "Instead, play it safe and wait to see where global stocks are six months from now. Overkill isn't the answer."
A nine-month deal could help keep prices more stable leading into OPEC's usual winter meeting in six months and keep oil relations harmonious within the producer group.
It also gives the coalition more time to develop what Igor Sechin, CEO of Russia's Rosneft, said is necessary: a "smooth" end to the deal that does not involve all the members re-flooding the market.
"The longer that OPEC engages in such market management, the more concerned market participants will become about the eventual end of the agreement," analysts with Barclays said in a note Tuesday. "Thus, we believe OPEC needs to articulate an exit strategy."
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'WHATEVER IT TAKES'
Falih, who arrived Tuesday in Vienna but declined to comment to reporters, has said multiple times in the last week that the producer group was prepared to do "whatever it takes" to draw down inventories to the five-year average, as OPEC has said is the goal.
But some OPEC watchers say the market rhetoric and interactions with traders bear the danger of making OPEC seem more interested in managing sentiment than actual supply.
OPEC Secretary General Mohammed Barkindo has made engagement with hedge funds and trading houses a priority, meeting several times with managers that many within OPEC had long derided as speculators.
"This focus on hedge funds and financial players is good for understanding, but it still speaks to OPEC's underlying belief that speculators have a bigger role than physical balances," said Jamie Webster, a fellow at Columbia University's Center on Global Energy Policy.
OPEC and its non-OPEC partners will have to prove to the market that they remain committed to the cuts, with many analysts saying they doubt compliance will remain high as the deal goes on, particularly in the summer peak demand season in the Middle East.
The monitoring committee found that OPEC and non-OPEC compliance with the deal reached 102% in April. OPEC achieved 107% of its cuts, while non-OPEC participants achieved 92%, as Russia only recently attained its full 300,000 b/d cut commitment.
The International Energy Agency, however, is less upbeat about non-OPEC compliance, pegging it at 66% in a recent report.
"Perhaps more so than in the recent past, the oil market is data dependent, waiting on the tangible signs of declines in visible oil stocks and exports before buying into OPEC pledges," Harry Tchilinguirian, an analyst with BNP Paribas. "In turn, OPEC will need to maintain strong compliance to prove effectual in reducing the global oil inventories."
--Staff reports, firstname.lastname@example.org