By all indications, OPEC and its non-OPEC partners will extend their historic supply pact when they meet in Vienna on November 30. The only debate is whether the extension will be for six or nine months. As it stands now, the deal, which went into effect on January 1, will last through March 2018. So far in 2017, it has managed to slash the OECD stock overhang by more than half—from the peak of 380 million barrels above the five-year average to 140 million barrels in October.
“Additionally, excess crude in floating storage has been drawn down considerably, by 50 million barrels since June 2017,” OPEC Secretary-General Mohammad Barkindo noted in his opening remarks in Vienna on November 27. “[For] the first time since the summer of 2014, all major crude oil benchmarks have flipped into backwardation, signaling clearly a market that is steadily returning to balance.”
Compliance varies among the 22 countries which agreed to cut output by 1.8 million b/d in an effort to boost prices. From January through October, the 12 OPEC members which agreed to restrict supply have cut almost exactly as much as promised, achieving an historic compliance rate of 98%. Over that same period, the supply pact’s 10 non-OPEC members achieved roughly 80% of their promised cuts. Oil markets have tightened as a result. The Brent benchmark is up by one-third from lows seen this summer and prices have come to rest above $60/barrel for the first time in more than two years.
Yet OPEC and others aren’t declaring victory. Many want to play it safe instead.
Those pushing for a nine-month extension through the end of 2018 are worried that stocks will not fall steadily or significantly in the first half of next year. Thus, a longer extension is considered safer because it’s bolder and reaffirms that the OPEC/non-OPEC alliance is unified and willing to do whatever it takes. A nine-month extension also doesn’t preclude a reassessment sometime next year. A less ambitious six-month extension (through September 2018) is another option. But that compromise could be received as a half-measure by market watchers and traders whose expectations have been raised recently. Anything less than six months would be an anti-climactic copout, sure to push prices down.
An extension is virtually guaranteed, but today’s overwhelming consensus masks real divisions, complications and misgivings.
An extension is virtually guaranteed, but today’s overwhelming consensus masks real divisions, complications and misgivings. To fully appreciate OPEC’s predicament, it’s important that we understand where each member of the pact stands now. To do that we can break down the 14 OPEC and 10 non-OPEC contributors into five categories: the heavy lifters, who’ve cut more than others or more than was expected; the slackers, who haven’t kept their commitments; the compliant, who have; the exemptions, who got a free pass; and the non-factors, whose compliance matters less because they produce so little.
The Heavy Lifters (Saudi Arabia, Russia, Mexico and Venezuela): Saudi Arabia stands as the single-greatest contributor by far, having slashed production by nearly 600 thousand b/d from its October 2016 baseline volume. Saudi compliance over the first 10 months of the deal averaged 122%. Clearly, OPEC’s number one producer feels its credibility is on the line. Reinforcing those cuts are others from Russia, the pact’s largest non-OPEC contributor. Russian cuts were phased in gradually over the first half of 2017 and output is down by 300 thousand b/d from last year’s high of 11.2 million b/d.
The Saudis are reportedly pushing hard for a nine-month extension, while Russian officials and oil company executives have expressed reservations. If “Super OPEC” settles on a six-month extension, it will be because Russia would not commit to anything longer. A nine-month extension, however, would signal that Russian-Saudi cooperation has really hit its stride.
Another heavy lifter is Mexico, which has been a reliable contributor all along, offering the second-largest cuts (by volume) of any non-OPEC participant.
Another heavy lifter is Mexico, which has been a reliable contributor all along, offering the second-largest cuts (by volume) of any non-OPEC participant. Starting in January, Mexico cut by about 100 thousand b/d. It maintained strong compliance throughout the year. Output dipped in August but dropped significantly in September when hurricanes curbed production. Mexico hasn’t fully recovered yet.
Meanwhile, Venezuela wishes it could halt its production slide. Since the deal took effect in January, output has dropped by almost 150 thousand b/d—even though Venezuela committed to cutting just 95 thousand b/d. (It’s down more than 400 thousand b/d since January 2016.) Clearly, Venezuela’s oil sector is bleeding and there’s no reason to expect a recovery when it’s only becoming more politicized and more militarized.
The Slackers (UAE, Iraq, Kazakhstan, and Malaysia): Through the first ten months of the deal, the UAE cut production by just two-thirds of what it promised (139 thousand b/d), while Iraq barely cut production by half of what it agreed to (210 thousand b/d).
The UAE will take on the rotating OPEC presidency next year. It may thus become more inclined to satisfy its commitments. At the very least, its failures will be harder to overlook, because it will be tasked with managing the deal. Iraq’s weak compliance has been a source of much drama because officials disagree with secondary source estimates for production. That became less of an issue last month when the Kurdish independence referendum prompted federal security forces to recapture oil-rich territory in the north. When the Kurds lost Kirkuk, they lost almost half of their oil production. Much of that oil is now stranded with nowhere to go, leaving Iraq more compliant than ever—probably for a while yet.
Kazakhstan and Malaysia are the most conspicuous slackers among the non-OPEC crowd. Kazakhstan was not an enthusiastic contributor to start, because it planned to increase production going into 2017, and it likely will not cut 20 thousand b/d as promised. Malaysia raised output this year instead of cutting 20 thousand b/d. These undelivered cuts aren’t hurting the cause much, whereas OPEC needs the UAE and Iraq to lead by example because of their status as two of OPEC’s top five producers.
The Compliant (Algeria, Angola, Azerbaijan, Iran, Kuwait, Oman and Qatar): There isn’t much to say about these contributors other than that they mostly kept their word, with some month-to-month variation in volumes.
The Exemptions (Libya and Nigeria): During the worst stretches of 2016, Libya and Nigeria each lost about one million b/d to conflict or sabotage. Their production outlooks were so doubtful that OPEC could not possibly ask them to contribute. Libyan volumes briefly fell to a shockingly low 200 thousand b/d last summer; they recovered in the fourth quarter last year and bounced around this year before plateauing at about 1 million b/d. Militancy in the Niger Delta drove Nigerian production down to about 1.2 million b/d last year—its lowest level in three decades. Production there has rebounded to 2 million b/d.
Recoveries in Nigeria and Libya are still tenuous.
Unfortunately, these recoveries are still tenuous. Libyan output is still threatened by countless spoilers, both violent and non-violent, who wish to take the oil sector hostage if only to wring concessions out of the government. Others like ISIS still aim to cause havoc in the oil patch. In Nigeria, peace talks between the government and various Delta leaders have only sputtered this year. The government has yet to deliver on its promises and even if it does local communities may not be satisfied enough to keep militants in check. Should talks stall or patience run out in the Delta, militancy will return full force, and production will fall accordingly. Both producers seem set to receive another free pass.
The Non-Factors (Bahrain, Brunei, Ecuador, Eq. Guinea, Gabon, Sudan and South Sudan): These seven small producers were to cut by 70 thousand b/d combined. That amounts to merely 4% of the 1.8 million b/d in total cuts agreed to in Vienna last year. Thus, their compliance or lack thereof is not going to move markets. None of these producers are in a position to ramp up production either. Ecuador quit the Vienna agreement in July but has since come around and will rejoin the pact because it’s working. If, in fact, more producers from Africa and Central Asia sign up for cuts in Vienna, they could conceivably pick up the slack for the non-compliant and less important producers.
Going into 2018, OPEC and its partners can take credit for the market turnaround. But the Vienna deal is underpinned by a fragile consensus that needs constant attention and careful management.
Going into 2018, OPEC and its partners can take credit for the market turnaround. But the Vienna deal is underpinned by a fragile consensus that needs constant attention and careful management. Compliance could still slip if prices steadily improve. Until recently, OPEC had to convince skeptics that the deal was working, albeit more slowly than many would have liked. Very soon it will have to come to terms with what success means for it and other price-sensitive producers, especially U.S. shale. Negotiating an orderly end to this period of extraordinary cooperation and restraint may be the trickiest part.