Last week, a Bloomberg energy journalist tweeted from Riyadh, wondering why there are no mass celebrations of the fact that Brent was coming closer to $60 a barrel. Now that the international benchmark has passed the $60 barrier, one could imagine the top OPEC men rejoicing, albeit in private, as this was the much-coveted price level the cartel was after from the start.
Yet, this price level may provide an undesired outcome for OPEC, as some analysts have been warning for a while now. Here’s the danger: OPEC members have a history of cheating on production quotas. They’ve been cheating in this deal, too, with Saudi Arabia covering for them by pumping less than it agreed to. With Brent at $60, the temptation to cheat more may simply become too strong to resist.
The latest to sound the alarm was Stephen Brennock, a PVM Oil Associates analyst. Speaking to CNBC, Brennock noted that OPEC faces three challenges for the further success of its production cut deal.
First among these has to do with Libya and Nigeria, the exempted members of the cartel, which have since January brought on an additional 694,000 bpd to global supply. While Nigeria has signaled a willingness to cap its output at 1.8 million bpd, its current level, there’s nothing to guarantee it will go ahead with the cap now that Brent is over $60.
The second and the third challenges are related: The cheating has to stop, but how do you make it stop when prices are higher and there are markets with growing demand that producers outside the cut deal, chiefly U.S. shale boomers, would only be too happy to satisfy?
U.S. exports of crude oil hit a record of over 2.1 million bpd last month and they will only continue to grow as long as the spread between Brent and WTI remains as wide as it is now, making U.S. crude more attractive than Brent-tied Middle Eastern grades.
Russia is also taking over market share from OPEC thanks to the fact that its cut quota is a meager 300,000 bpd, which was cut from record-high daily production rate last November.
OPEC indeed has a lot of work to do to convince everyone to play by the rules. There is market-share grabbing among OPEC producers themselves: Iraq and Iran are growing their exports at the expense of Saudi Arabia, which has capped its shipments abroad to 6.6 million bpd last August.
Or let’s look at the latest price rally: it was caused not by major fact-based news about global supply falling within the OECD five-year average. Rather, it was caused by comments from Russia’s President Putin and Saudi Arabia’s Energy Minister and Crown Prince that they will back an extension of the production cut deal.
While strong backing from the two leaders of the cut deal could speak volumes about the chance of the deal succeeding in eventually bringing supply down to the target level, but it’s by no means enough. If it was, compliance would be 100 percent from the get-go, which hasn’t been the case.
What’s an oil cartel to do in this situation? Perhaps the leader of the pack, Saudi Arabia, could somehow spread the “whatever it takes” attitude around with the argument that the more you comply, the higher prices will rise. Or an even better argument: if you don’t play ball, prices will drop to $40 a barrel, a not-impossible development.
Irina Slav is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.
Frontpage February 16, 2019