OPEC approaches its May 25 meeting in Vienna with an oil market seemingly captured in a production glut narrative. This is not how it was supposed to go.
When OPEC announced its 6-month production cut deal in November, it was widely expected (not by us) to start reducing massive global crude inventories by the spring of 2017 and bring the market close to balance by the end of the year. As a result, oil prices rebounded due to OPEC’s action and the news that Saudi Arabia had cut more than was required under the deal terms.
But US producers also responded to OPEC’s efforts. Since the OPEC deal was announced, US producers added 600,000 barrels a day (b/d) of crude and now approach a total of 9.3 million b/d. EIA has recently revised its estimate for US production to 9.64 million b/d by the end of the year.
And then there is the “US Rig-covery” as we like to call it. Since the OPEC deal was implemented in January, US producers have added 178 oil rigs for a total of 703 oil rigs – more than double a year ago.
The big topic on OPEC’s agenda for this upcoming meeting has always been whether to renew the production cut deal. When the deal was announced in November, it included an option to extend for another 6 months. The market viewed the extension as automatic, and it was priced in after OPEC began implementing the deal.
OPEC continues to maintain that its production cut deal is working but significant crude stock draws have yet to materialize. The market has turned bullish, and therefore, an automatic extension will no longer cut it.
OPEC needs to change the bullish market narrative, and its playbook in the case calls for a surprise. When asking our OPEC friends recently about the length of the extension, we were getting coy responses.
Then on Friday, Platts reported Kazak officials had held meetings last week with Saudi officials who had discussed the possibility of a 9-month extension. Over the weekend, Saudi Energy Minister Khalid Al-Falih said in Malaysia that he is “rather confident that the agreement will be extended into the second half of the year and possibly beyond.”
How quickly sentiment has changed. Back in February, Saudi Arabia was raising the possibility of no extension because the market fundamentals were already coming into balance. Now the Saudis are raising the possibility of a longer extension.
An automatic extension of the deal for another 6-months probably would not have prompted any bump in prices but an extension into 2018 will likely provide some price support. We think a longer extension is likely but may perhaps include a “safety valve” if market circumstances warrant. The details are still fluid.
In addition to its own extension, OPEC also needs the non-OPEC participants to agree to sign on to an extension.
Russia said recently it “supports an extension” but has sent mixed signals on whether it will join again.
In our view, Russia will sign on again but whether it actually cuts production by its pledged target is another open question. It doesn't seem to matter that Russia had the worst compliance rate of all the producers but OPEC desperately needs them to help change the narrative.
CONFERENCE CALL TO PREVIEW OPEC MEETING WITH FORMER OPEC PRESIDENT:
CALL INFO:
Speaker: Former Algerian Energy Minister & OPEC President Chakib Khelil
Friday, May 12 at 11:00 AM Eastern Time
Participating Dialing Instructions
UK: 0
Confirmation Number: 13661739
