Don’t Count On An OPEC Deal Extension

By Irina Slav

A year ago this week, markets reeled from the surprise election of U.S. president Donald Trump, and eagerly awaited OPEC’s November meeting as the last hope for an oil price rally. This year, all eyes are on the Middle East, the Saudi political purge, and the heating-up of tensions between the kingdom and Iran. Meanwhile, OPEC once again prepares for its November 30 meeting in Vienna, where most expect it will announce another extension of its oil production cut agreement.

Bloomberg Gadfly’s Liam Denning’s recent account of the OPEC deal a year into the cuts suggests the current situation is similar to this time last year, with one notable exception. Last year, Denning says, investors and traders were highly skeptical of OPEC’s ability to really change prices by controlling production. Cheating was the leitmotif of this skepticism. This year, he notes, expectations are so bullish that net long bets on crude oil are now higher than they were right after the initial agreement was announced.

In the 12 months between November 2016 and November 2017, several things that used to be just suspicions or suggestions became evident: that OPEC is no longer the master of oil markets, capable of swinging prices higher or lower whenever it fancied; that U.S. shale is here to stay and grow; and that, were it not for demand growth and the latest developments in the Middle East, Brent would never have returned to $60 a barrel solely as a result of OPEC’s production cut efforts.

This conclusion may be painful for the cartel, but there’s plenty of evidence to support it. Despite the numerous ‘compliance is great’ remarks in recent months by senior OPEC officials, production is down, demand is up, nobody is cheating, and global inventories are falling; it took the Saudi purge in Riyadh and the threat of war for prices to really snap back. They are now at levels last seen two years ago.

This price jump is now beginning to worry some analysts. It’s a simple truth that the higher the price of Brent, the more irresistible the temptation for OPEC members to cheat on their production quotas. What’s more, there’s a slim chance that the cartel will decide that the effect that tensions in the Middle East are having on oil prices will be sufficient to keep prices high without a deal extension. After all, the conflict between Saudi Arabia and Iran potentially threatens some 14 million bpd of crude, which is the combined production of the two archenemies. That’s 40 percent of OPEC’s total production.

Another possible outcome of November’s OPEC meeting is the delay of the decision that everyone seems to expect. Earlier this month, Russia’s Energy Minister Alexander Novak hinted that the decision may be announced later, depending on what the latest market data says about oil’s fundamentals. This delay would harm prices, but in light of the overwhelming optimism that an extension will eventually be approved, the effect is unlikely to be a lasting one.

Ultimately, an extension is the most likely outcome, as OPEC simply can’t afford to end the production cut agreement. But with rising regional tensions and the possibility of a major military escalation, nothing should be ruled out.

 

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