The Bullish Truth Of OPEC’s Agreement

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By Nick Cunningham

Oil prices jumped 5 percent on Friday after the OPEC+ group announced its vague decision to maintain its collective target while lifting country-specific limits on oil production. The result was viewed as only a modest increase, which could lead to tighter supplies.

Over the weekend, Saudi officials sought to clarify, adding that the move would lead to the increase of 1 million barrels per day. That caused prices to fall back a bit on Monday.

“There’s still some uncertainty in the market as far as how everything is going to start to unwind,” Mark Watkins of U.S. Bank Wealth Management told Bloomberg. “Ahead of that, a lot of people were thinking the worst case scenario as far as OPEC’s going to open up the spigots and oil is going to flood the market again.”

However, the assumption that OPEC is going to flood the market made no sense to begin with, and the result should not be read as a bearish result. OPEC is not going to open the spigot, and if anything, the risk to oil prices is decidedly on the upside. Most OPEC members cannot increase output, even if they wanted to. The oil market may only see 600,000 bpd of extra supply.

That will have only a marginal impact on the market, amounting to less than 1 percent of supply. It would simply offset the declines from Venezuela over the past year. But the declines from Venezuela are not stopping there. They are set to continue, perhaps at an accelerating rate. And they are not the only ones seeing sudden disruptions in supply. Libya temporarily lost 450,000 bpd over the last two weeks and Nigeria is also suffering from lower exports because of pipeline issues. Also, the market seems to have forgotten about the expected losses from Iran, perhaps because there is still a lot of uncertainty over how bad the disruptions will be. The latest on that front is not encouraging. The U.S. government has asked Japan to completely halt oil purchases from Iran, a stricter request than what came from the Obama administration. Iran admitted that a lot of buyers won’t receive exemptions from Washington, which could go a long way to curbing Iranian exports.

Moreover, there is always the chance that unexpected disruptions occur elsewhere. News just broke that Canada’s oil exports could fall by 360,000 bpd in July because of an outage at an oil sands facility run by Syncrude Canada.

Most importantly, the sanguine outlook towards the oil market over the next year is largely based on massive production increases from the Permian basin in the U.S., but pipeline constraints could slow growth in Texas.

Meanwhile, Saudi Arabia and Russia are discussing a more permanent framework for cooperation, perhaps some sort of “Super OPEC” in which the OPEC and non-OPEC countries currently cooperating agree to create a parallel institution, separate from OPEC itself, that coordinates oil market policy. Bloomberg reports that the new group could change the one member, one vote policy to something that grants more power to larger producers.

Proponents would cite that bringing Russia and others into an official body would grant the group more influence over global oil markets by folding a greater share of global production under market management. Critics would note that many OPEC members are already producing at maximum capacity, and some of them have falling outputs, which means that their discretion to raise or lower output is a mirage. Also, critics would question the long-term viability of cooperation between so many countries with such disparate interests.

Nevertheless, an expanded OPEC/non-OPEC alliance on an official basis, should it occur, would mark the largest change to oil market management since the creation of OPEC decades ago

However, even if Saudi-Russian cooperation persists for years to come, it wouldn’t change the fact that the oil market is still tight and the addition of Saudi oil to the market lowers global spare capacity. “The global oil market will likely continue to experience a deficit under most scenarios,” Bank of America Merrill Lynch said in a note. The bank sees Brent rising to $90 per barrel in the second quarter of 2019.

Ultimately, the goal of OPEC and its non-OPEC partners since 2016 has been to drain the surplus and bring the market back into balance. Now, with the market balanced, it would make little sense for them to flood the market. As such, the agreed upon increases are intended “to keep inventories towards more normal levels and not push the market into oversupply,” Goldman Sachs said in a note.

Saudi Arabia, as always, will have the final say on how much oil is added to the market. And with the IPO of Saudi Aramco still scheduled for 2019, there is little chance that Riyadh will preside over another market meltdown. Indeed, any effort to boost production will be aimed at preventing a price spike as more and more barrels go offline around the world.

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