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Is OPEC Deal Compliance About To Crash?

Tsvetana Paraskova

OPEC is declaring victory in its efforts to rebalance supply and demand and bring the oil market back to stability—its favorite proxy buzzword for less volatile and relatively high oil prices.

While OPEC is taking credit for some of the oil price rally in recent weeks, a number of various other factors have combined to push oil prices up—strong oil demand growth, weaker U.S. shale growth, falling U.S. inventories, and the return of some geopolitical risk from the Middle East with the Iraq-Kurdistan standoff and Saudi government purge.    

As the November 30 OPEC meeting draws closer, if oil prices remain ‘stable’ (or more or less at their current levels of WTI at nearly $57 and Brent at $63.50 as of Thursday morning) until the end of this month, the cartel and its non-OPEC allies led by Russia might not feel the urgent need to decide on an extension of the production cuts at end-November. The oil market seems to have priced in an extension to the end of 2018, and should OPEC fail to communicate its short-term intentions on ‘fixing’ the balance, it will leave a lot of market participants disappointed.

Moreover, at higher oil prices, some OPEC producers could be tempted to cheat (even more) and the surprisingly high overall compliance, of which the cartel is so proud, could quickly fall apart.

OPEC’s mission to draw down bloated global oil inventories with production cuts came at a time when global economic growth is strong and oil demand growth is stronger than previously expected. Then, U.S. shale production growth started to show signs of a slowdown, and some analysts think that the biggest leaps in lowering costs across the U.S. shale patch may be already behind us.

The sentiment on the oil market is as bullish as it has been in years, but analysts are divided—as usual—on whether this bullishness is entirely due to market fundamentals and whether the bulls will feel the sting of an imminent oil price correction.

Last month, OPEC Secretary General Mohammad Barkindo said at the Oil & Money conference in London:

“There is no doubt that the market is rebalancing at an accelerating pace; stability is steadily returning; and there is far more light at the end of the dark tunnel we have been travelling down for the past three years.” 

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The OECD stock overhang was 159 million barrels above the five-year average in September, down from 338 million barrels above the five-year average at the beginning of 2017, Barkindo said.  

On this front, after a slow start to the year, the OPEC cuts are paying off. But it’s also the demand growth that is reducing the global overhang.

“Demand considerations have attracted relatively little attention,” Stephen Brennock at London-based broker PVM told the Financial Times at the end of October. “Yet they have also played their part in hastening the rebalancing process,” he noted.

The oil price rally of the past couple of weeks isn’t a speculative move, according to Paul Horsnell, global head of commodity strategy at Standard Chartered. “We think the move reflects the start of a widespread re-evaluation,” he said, as quoted by Bloomberg.

Michael Poulsen, senior oil risk analyst with Global Risk Management, warns that the “greatest leaps forward in lowering costs are now behind us”, referring to the ability of U.S. shale to drive breakeven prices down.  

The voices that U.S. shale might underperform expectations could only be a bullish sign for oil prices. But higher prices are a double-edged sword for OPEC—not only due to a possible renewed resurgence of U.S. shale, but also because of its own far-from-perfect track record of sticking to pledges when oil prices rise.

“OPEC is good at holding the line when oil prices are low, but when prices are strong, the discipline can break down both in OPEC and non-OPEC,” Fereidun Fesharaki, chairman of industry consultant FGE, told Bloomberg.

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While both Saudi Arabia and Russia have signaled that they’re open to extending the cuts through end-2018, and the market is largely expecting this, there are growing voices that the current higher oil prices will discourage OPEC and the Russia-led non-OPEC partners from committing at month’s end to rolling over the cuts to December 2018.

“Our base case is that we do not get a full-year extension on November 30,” Ed Morse, head of commodities research at Citigroup, told Bloomberg. According to Morse, OPEC will either postpone a definite decision to early next year, or just extend the cuts by three months.

Russia’s Energy Minister Alexander Novak has already hinted that the decision would likely come at a later stage.

If oil prices don’t fall much from their current levels until the November 30 meeting, some OPEC producers, as well as Russia, could be reluctant to commit to specifics until they see how the market will look like in early 2018. An OPEC extension is likely, but the current uptick in oil prices, rising geopolitical risks, and a steady decline in global stockpiles could push the definitive decision into 2018. And instead of giving the market what it has expected for months, on November 30 OPEC could just reiterate its other favorite phrase: ‘All options are left open.’  

By Tsvetana Paraskova for Oilprice.com

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