OPEC’s ‘Modest’ Aims Won’t Be Enough

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By Nick Cunningham

The OPEC+ meeting is just days away and it seems all but certain that the result will be some sort of increase in production, although the magnitude of the output increase remains to be seen. Another thing that seems all but certain is that the meeting will be incredibly contentious, with Saudi Arabia and Russia likely peeling off from the rest of the group.

Russia has proposed an aggressive 1.5 mb/d production increase from the OPEC+ group, but many of the OPEC members oppose any increase at all. The gap between these two positions is so wide that it seems irreconcilable.

Saudi Arabia is trying to mediate, and is trying to balance competing interests – it wants to keep up the group’s cohesion, while also trying to adequately supply the market and solidify a more permanent cooperative framework with Russia. The Saudis also want to keep prices up for its Aramco IPO, but not so high as to destroy oil demand and/or spark too strong of a response from U.S. shale. The interests may be incompatible, but it appears the Saudi strategy is to split the difference and push for medium-sizedproduction increases of around 300,000-600,000 bpd over the next few months.

But because so many OPEC members have no ability to increase output, they are dead set against any increase. The reports that the Trump administration directly asked Saudi Arabia to boost oil production to make up for the expected shortfall from Iran following the return of U.S. sanctions has also made negotiations much more difficult. Saudi Arabia’s close alliance with the U.S., which typically hasn’t affected the inner workings of OPEC, has poisoned the well.

That means that Saudi Arabia will likely be unable to drag the rest of OPEC along with a formal agreement on an increase in output. What could emerge is a sort of bilateral agreement between Riyadh and Moscow. While they still disagree on the precise volumes of additional oil, they both are highly interested in not only coming to an agreement, but formalizing some sort of more permanent framework for cooperation.

How all of this works out in practice remains to be seen, but it could mean the current deal is formally left untouched, and Saudi Arabia and Russia reach some sort of tacit or parallel agreement to increase output. Based on the latest reports, the middle of the range at about 500,000 bpd seems roughly where they are right now.

Saudi oil minister Khalid al-Falih said last week that an increase in output is “inevitable,” but he is trying to walk a fine line by reassuring the world that it won’t be a tidal wave of fresh supply. “As usual we will do the right thing,” Khalid al-Falih told reporters in Moscow on Thursday. “I think we’ll come to an agreement that satisfies most importantly the market.”

“I think it will be a reasonable and moderate agreement,” al-Falih said. “It’s not going to be anything outlandish.”

However, what makes this story even more complex is the fact that the oil market is calling for more supply. The utter collapse of Venezuelan production means that Russia’s position looks closer to the mark than the “no increase” mantra from the rest of OPEC, and arguably even Saudi Arabia’s position.

According to S&P Global Platts, even if the group increases output by 1 million barrels per day – definitely on the more aggressive end of the menu of options – the global oil market could still see inventories draw down at a rate of 400,000 bpd by the end of 2019. That assumes another 500,000 bpd loss of Venezuelan supply between now and then, plus a 900,000-bpd decline from Iran.

In other words, the position favored by Saudi Arabia could still leave the market short on supply by next year, and could lead to much higher prices. Riyadh still seems to prefer that more “modest” option, if only to avoid a total fracturing of OPEC, but it isn’t clear that it will be enough to bridge the supply gap.

Of course, nothing is decided yet and the group is considering a range of options. Saudi officials might also look at the collapse underway in Venezuela, the potential outages in Iran, the unexpected recent outage in Libya, and come to the conclusion that it needs to be bolder. A recent report that Saudi Arabia and Russia discussed a two-step process of adding 500,000 bpd in the third quarter followed by a 500,000-bpd increase in the fourth quarter, might make more sense than the idea of only increasing by around 300,000 bpd, which was reportedly Saudi Arabia’s preferred option a few weeks ago.

The upcoming OPEC meeting is set to be the most dramatic since late 2016 at least.

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