News Flash – OPEC Extension
Energy Managed.
20 April 2017
In our last News Flash entitled “Increased Volatility Ahead” we concluded by stating – ‟we suspect that
in the coming weeks/months we will see an elevated level of volatility as the market oscillates between
bearish fundamentals and continued news flow from OPEC to support the current price.” At the time
we released our note, WTI and Brent were just below $55 and $57 per barrel respectively – riding a
wave of optimism from the recently enacted OPEC production cuts. In March, prices fell roughly 15
percent as the market struggled to understand why inventories were not declining as initially forecast.
In April, prices rebounded erasing most of their losses as OPEC members started talking about an
extension to the agreement. Yesterday, prices fell sharply after the release of US inventory data
showing crude production continued to climb, inventories declined slightly from record levels and
gasoline stocks unexpectedly increased. It seems heightened volatility will continue to plague the
market until the next OPEC meeting at the close of May.
Now more than halfway through the term of the OPEC agreement, crude oil inventories around the
world remain at or near record levels. While
compliance with the agreed production cuts
amongst OPEC members has been
impressive, this has not been the case with
non-OPEC participants. The production cuts
have failed to drain the global inventory glut,
built over the recent years, due to OPEC
members
rushing
to
ramp
up
production/exports prior to the start of the
agreement and rising production in the US,
Libya and Nigeria. Moreover, slack demand
in the US and Europe has also acted to counterbalance the OPEC’s production cut.
At present, the lion’s share of OPEC’s output reduction is being borne by Saudi Arabia. As a
consequence, Saudi Arabia and certain other OPEC members, have been ceding market share to Russia
as well as other major producers. In recent weeks, several OPEC members have been openly stating
their willingness to extend the agreement. By and large, the extension has already been priced into
the markets. The question raised by the current situation is - what is the likelihood of such an
extension?
An extension of the current OPEC agreement is more complex than it appears on its surface. First,
many of the production cuts undertaken by OPEC members were the consequence of bringing forward
field maintenance. Now that maintenance has been completed, these members will be faced with a
difficult choice – halt production on an operative field or put the field back on line and generate
additional revenue. Second, to-date, Saudi Arabia has exceeded its required level of cuts under the
agreement, making up for the deficits of other cartel members. It is unclear whether Saudi Arabia
would be willing to continue to shoulder this burden and, if so, what it would want in return for doing
so. Third, in the original agreement, Nigeria, Libya and Iran were exempt. Any future arrangement,
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would most likely require these members to contribute by reducing, or capping, production. Finally,
at present, non-OPEC participants (particularly Russia) have failed to fulfil their commitments under
the existing agreement. Any negotiations concerning an extension would clearly need to address this
point and attempt to implement some type of meaningful compliance mechanism.
Despite the market’s view that an extension is largely a foregone conclusion, negotiations amongst
OPEC and Non-OPEC participants will be delicate. As a consequence, there is a significant downside
risk surrounding this event. Specifically, should OPEC resolve all issues raised herein and implement
an extension, markets would clearly see this as price supportive. However, any resulting upward
movement in price would most likely be modest as traders will be eager for evidence that inventories
are finally declining. Alternatively, should OPEC and non-OPEC members fail to come to an agreement,
this would be disappointing to the market and prices would immediately pull back sharply. At present,
it is difficult to determine the balance of probability as to the outcome. There can be little doubt OPEC
members understand the impact of failing to reach an agreement. On the other hand, these very same
members will come to the negotiating table with different economic and political interests. With prices
languishing around the $50 per barrel level, they will be feeling the pressure to increase revenues.
If negotiations become too difficult, it would not be surprising to see OPEC members agree to a 3month extension rather than come away from the meeting empty-handed. Such a result would most
likely disappoint the market for it would quickly become clear that 3 months is not enough time to
rebalance the market.
We fully expect that in the coming weeks there will be a good deal of news flow from OPEC members
attempting to jawbone the market. However, the real event will be at the end of May when the OPEC
members meet to make a final decision.
For additional energy news and information, follow us on Twitter @nusconsulting.
*****
The material contained herein represents the opinion and views of NUS Consulting Group (“NUS”) and is provided to discuss general
market activity, industry and sector trends, as well as other broad-based economic, market and political conditions. This information
should not be construed as research or investment/purchasing advice. Persons responsible for the purchase of energy for an organization
must consider their organization’s own objectives, risk tolerance and market forecast when undertaking energy purchasing decisions.
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