Oil prices have fallen so far in the past month that OPEC is clearly growing concerned about a downturn.
Saudi Arabia and Russia will explore the possibility of a production cut for 2019, a move intended to head off a renewed supply glut. Surging U.S. shale production, plus higher output from Russia, Saudi Arabia, the UAE, Iraq and Libya, has more than offset the declines from Iran, at least so far. Inventories have climbed sharply in the U.S., and shale production in recent months has exceeded expectations.
Nevertheless, a production cut would be a dramatic turnaround for the oil cartel, which until recently had to repeatedly reassure the oil market that supplies were adequate and that they were prepared to meet any hypothetical shortfall with fresh supply.
The course correction is jarring. “The message from OPEC looks like: fasten the seat belts,” Bob McNally, president of Rapidan Energy Advisors LLC, told Bloomberg. OPEC will essentially “put pedal to the metal to boost production, and then immediately slam the brakes pretty hard and talk about cutting supply.”
Saudi Arabia has been worried about this scenario for several months at least. When oil prices were rising over the summer, and again in September, Saudi officials pointed to upcoming seasonal demand weakness in the winter. “There are more demand threats next year compared to supply threats,” an unnamed Saudi source told Reuters in September. Still, the markets were concerned about shortages, Brent jumped to the mid-$80s per barrel, and there was widespread speculation about the extent of Saudi spare capacity.
A month and a half on, Riyadh and Moscow are mulling over a production cut. A lot has changed in such a short period of time. Libya restored a huge amount of disrupted supply. Saudi Arabia ramped up production to 10.7 million barrels per day, up 700,000 bpd since the OPEC meeting in June. Perhaps most importantly, the U.S. has been producing a lot more oil than previously thought. In August, production jumped by more than 400,000 bpd from June levels, an unbelievably large increase.
On Wednesday, the EIA reported yet another large crude oil inventory increase, with stocks jumping by 5.8 million barrels in the first week of November, up to 431.8 million barrels. Shockingly, the EIA said the U.S. produced an astounding 11.6 mb/d for the week ending on November 2. The weekly figures tend to be a bit less reliable, and are subject to revision later on. But the figure is still a sign that shale production is growing very rapidly.
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“The US Energy Information Administration now predicts that it will increase to 12 million barrels per day in the second quarter of 2019. Originally this was not expected to happen until late 2019,” Commerzbank said in a note. “This will force OPEC to reverse its latest increase in oil production by roughly 1 million barrels per day again if it does not want to risk a massive oversupply and a further slide in oil prices.”
To top it off, the Trump administration’s decision to grant waivers to eight countries importing Iranian oil takes a lot of the edge off the market. This alone helps explain a lot of the motivation behind Saudi Arabia’s renewed interest in production cuts for next year. If around 1 mb/d of oil exports from Iran is no longer going offline, that almost completely removes the need for more Saudi supply. With Iran still online, the rest of OPEC may now need to reduce production.
Which is exactly what the Iranians are saying. “Saudi Arabia and Russia have increased production, and prices have come down $15 a barrel,” Hossein Kazempour Ardebili, Iran’s representative to OPEC, said in a Bloomberg interview. “They have over-balanced the market,” and now need to eliminate 1 mb/d of production.
To top it off, the global economy is facing some major questions marks, especially as we head into 2019. Any slowdown will hit crude oil demand. “They will absolutely want to at some point next year try to arrange a reduction in production,” said Ed Morse, head of commodities at Citigroup Inc., according to Bloomberg. “Everything points to a fairly weak balance: the world economy is decelerating, the China trade tensions are having a visible impact on demand.”
It would be difficult to achieve consensus from the more than dozen OPEC member countries, but then again, Saudi Arabia and Russia have demonstrated that they can do what they want on their own, even if the rest of OPEC opposes them.
The bottom line is that even the mere rumor of a production cut offers some evidence that the oil market is a lot looser than it was a few weeks ago. The head of the IEA warned that the oil market is “not out of the woods yet,” pointing to the “free-fall” in Venezuelan production. However, sentiment has clearly shifted. “The market has yet to prove that it can hold onto a rally, so the short-term mood is still very negative,” Phil Flynn, analyst at Price Futures Group, told Reuters.