November 28, 2016
In September, in a concerted effort to stem the fall in oil prices and accelerate the rebalancing of the global market, the Organization for Petroleum Exporting Countries (OPEC) announced the “Algiers Accord.” The accord called for OPEC members to freeze production levels somewhere between 32.5 and 33 million barrels per day (mmb/d) in hopes of drawing oil out of storage and thereby accelerating the rebalance by depleting the enormous global inventory overhang. In the months leading up to the November 30 OPEC meeting, a technical committee was assigned to work up individual country quotas, identify production cuts among members, resolve disputes related to individual country production data, and formalize country exemptions while member states encouraged other non-OPEC producers to join the agreement.
The Algiers Accord had two immediate impacts—both positive for producer interests. First, it avoided a repeat of the Doha debacle, where failure to agree on output restrictions resulted in a significant price reduction; and second, over the course of the next several weeks, buoyed by market sentiment supportive of an OPEC deal, prices not only stopped falling, but began a sustained rise back above the $50/barrel level, substantially increasing producer revenues over the period.
In the past few weeks, oil price movements have vacillated based on market fundamentals, sentiment, trade positioning, and dollar strength with skeptics of a possible deal emphasizing oversupply (OPEC and non-OPEC), weak demand, enormous stocks, etc., and evidencing that skepticism with short covering. OPEC’s October supply numbers (at 33.8 mmb/d) exceeded previous highs even as producers commented on the need for restraint, requiring a cut of between 800,000 and 1.3 million barrels per day to comply with the Algiers target. The month also saw positive, if fleeting, news from production increases in Nigeria and Libya.
In addition, non-OPEC volumes, supported by increases from Russia, Brazil, Canada, Norway, and Kazakhstan, continued to evidence storage growth (rather than depletion) while forecasts for demand, in China for example, were revised downward. In the United States, the election of Donald Trump, a professed pro-development candidate, bolstered the prospects for additional production and infrastructure projects, and company filings indicated a resurgence in hedges (having taken advantage of the recent $50 prices), thereby improving cash flow prospects and the ability to deploy additional capital in the field when companies believe conditions warrant. The U.S. rig count continues to grow (albeit selectively in certain oil producing basins) as productivity improvements render Tier 1 and some Tier 2 prospects economic even at current prices.
In the past week, as the OPEC meeting drew closer, shifting sentiment more supportive of a workable deal has caused investors to cover their shorts and become more bullish on prices. Rumors of plausible Saudi cutbacks (at least until summer “burn” requirements pick up later next year), coupled with positive rumblings out of other OPEC nations, as well as Russia, suggest some sort of agreement may well be in the offing.
So what can/will OPEC do?
The pressure on OPEC and its secretary general, Mohammed Barkindo, is enormous, and though no one underestimates the seriousness or sincerity of Saudi energy minister Khalid al-Falih when he admonishes fellow OPEC members that is it “imperative” to reach a credible agreement, the prospect for achieving and sustaining a meaningful cut (on the order of 800 mb–1 mmb/d) remains daunting but doable.
Over the weekend, mixed reports of the closeness of a deal moved prices yet again with some analysts suggesting that widespread skepticism about the inability of OPEC to come to a meaningful agreement was already reflected in the sub-$45 price. Others warned that markets would be unforgiving with further, more severe price declines forecasted if OPEC was unable to deliver as promised. This morning prices rose above $48 on rumors of Iraq’s willingness to join the agreement.
So what if OPEC is able to thread the needle this week? A Saudi reduction of some 400 mb/d coupled with commensurate commitments from the other Gulf states, an Iranian “freeze,” a recalculation of Iraqi volumes, and a nominal Russian contribution could get you in the ballpark, assuming the market believes the reductions are real and sustainable. Renewed production problems in Venezuela, Libya, and Nigeria would further support upward price momentum.
Such an outcome would clearly support prices above current levels, suggesting further/faster market tightening in 2017, and simultaneously achieve at least a short-term “Goldilocks” equilibrium—sufficient to bring in additional revenues and potentially draw down the excessive stock overhang without significantly eroding consumer demand. It could allow the political situations in Nigeria, Venezuela, and Libya to play out a bit longer and provide additional time for a (possibly) more informed assessment of 2017 demand. The danger for OPEC of course would be that sustained higher price levels would also encourage some degree of quick cycle investment and drilling that could again create an oversupply situation.
Alternatively, OPEC’s failure to agree on some sort of production limit this Wednesday—also a distinct possibility, given the proclivities of the various members—means a return to low/under $40 oil, which returns the OPEC revenue stream to pre-Algiers levels, with all the attendant concerns to member state budgets, but also (as we indicated in an earlier commentary) retards other new investment competition.
Since the Algiers Accord in September, OPEC has been able to make a bit of hay while the sun shines in terms of realizing an incremental $7–$8/bbl in increased prices. It also has been, through the power of pronouncements, astutely able to generate that sunshine.
As November 30 looms, the fortunes of global producers are riding on the success or failure of the Vienna meeting. Failure unequivocally means more quarters of financial distress and the renewed warnings of persistent underinvestment leading to price shocks within the next few years. Success could mean but a temporary return to higher prices, until new supply (from stocks or wells) catches up with market incentives, and the undulating pattern is repeated. Events, like supply disruptions or economic slowdowns can alter the timing, price, and balances, but fundamentally, for at least the next few quarters, the “long game” will be dictated by short-game decisions.
Frank Verrastro is senior vice president and holds the James R. Schlesinger Chair for Energy and Geopolitics at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Guy Caruso is a senior adviser with the CSIS Energy and National Security Program. Larry Goldstein is a senior associate with the CSIS Energy and National Security Program.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
© 2016 by the Center for Strategic and International Studies. All rights reserved.Photo credit: JOE KLAMAR/AFP/Getty Images