OPEC: Having Your Cake and Eating It Too-the Sequel
Last Friday (June 22), OPEC concluded its 174th meeting with the issuance of an artfully constructed communique and an even more ambiguous press conference designed to preserve the foundation of the organization’s previous production agreement, while balancing the need to put additional barrels on the market in the face of higher oil prices, robust demand, and the prospect of significant and looming supply concerns likely to emerge over the next several months.
The meeting began somewhat inauspiciously with representatives from Iran and Venezuela wanting member states to condemn the imposition of “illegal” sanctions and retain the current “freeze” arrangement, while Saudi Arabia and Russia, with support from the other Gulf Cooperation Council states, supported significant production increases. Ministers Khalid Al-Falih of Saudi Arabia and Alexander Novak of Russia were conspicuously absent from the first day’s panel discussions while Minister Bijan Zanganeh of Iran forcefully addressed the assembly, arguing that the group could not “have your cake and eat it too”—ironically the exact title of our previous Commentary on the topic and ostensibly the actual outcome of the meeting. And all this took place as Secretary General Mohammed Barkindo commended the group for its perseverance and success in pursuit of a common goal (reducing the overhang of global oil inventories) and argued for continued and expanded cooperation in achieving market balance.
As Friday ended, the OPEC contingent was able to retain the framework of the 2016 freeze agreement and allow for expanded/incremental new supply by essentially crediting the group’s collective overcompliance over the last 15-plus months and arriving at a notional increase of something less than 1 million barrels per day (mmb/d). Depending on which set of numbers one uses, May output figures appear to indicate compliance rates somewhere between 147 and 175 percent, suggesting that between 650 and 900 thousand barrels per day (mb/d) of additional supply could be accommodated while still achieving conformity with the original agreement.
The communique issued at the end of the meeting stated that the member countries will “strive to adhere” to the 100 percent conformity level (of the OPEC12 calculation) from July 1 through the end of this year. If aggregate OPEC12 production figures (May output came in at around 29.2 mmb/d) are used, the computed creditable expansion equates to something under 800 mb/d. However, since Libya and Nigeria were exempted from the initial freeze agreement, depending on how successful these countries are at restoring/retaining production increases, the overall OPEC number could be higher. Since no individual allocations were announced in connection with the agreement, the burden/opportunity for this additional supply is expected to fall to that small subset of producers currently holding spare capacity or are otherwise capable of increasing near-term output. As indicated in our previous Commentary, that group notably includes Saudi Arabia, Kuwait, the United Arab Emirates (UAE), and potentially Iraq from the OPEC side (along with Russia and other non-OPEC producers).
On Saturday, Russian and Saudi representatives met along with other OPEC and non-OPEC members of the alliance. Bloomberg described the Saturday agreement as being “just as vague” as Friday’s. By some accounts, the non-OPEC contingent, whose participation in the production freeze pact was always voluntary, had a collective May production figure some 220 mb/d above the target “cap.”
So Where Does That Leave Us?
Prior to the OPEC meeting, President Trump, along with other major consumers, notably India and China, pressed the alliance for additional supply in order to both stem the rise in oil prices and offset likely supply losses (e.g., from Venezuela, Libya, elsewhere) and continued market tightness as we enter the third quarter when oil sanctions on Iran kick in. The International Energy Agency (IEA) estimates that OPEC spare capacity currently sits somewhere between 3 and 3.5 mmb/d, but others suggest that number is significantly lower. All agree, however, that the bulk of that capacity resides in Saudi Arabia.
U.S. light tight oil continues to impress, although logistical constraints, especially pipeline bottlenecks in evacuating Permian oil and associated gas, could hamper or at least delay further near-term increases. Export facilities are also limited, though improving, and the quality and characteristics of much of the oil makes it a poor replacement for heavier Venezuelan crude and eventually will compete with other global lights as oil from Nigeria and Libya (among others) reenters the market with heavy discounts. The prospect of trade wars and oil tariffs may also make substitution a more formidable challenge.
And while Saudi Arabia has both the spare production capability and similar quality characteristics to be able to replace Iranian barrels, it also has higher domestic demands in the summer months as an additional 300 mb/d is burned in country to generate power for air conditioning.
Of the other OPEC members, additional supply can eventually come from Kuwait (especially if the Neutral Zone comes back online), the UAE, and even Iraq if logistical and political issues are resolved forthwith. On the non-OPEC side, the largest likely (near-term) contributor is Russia, but even here the expectations are for an additional 100 to 200 mb/d over the next several months.
As a consequence, market watchers speculate that near term, the likely incremental supply we can expect to see over the coming months is 500 to 700 mb/d, or less than half of the increase Russia was advocating for—an outcome that poses substantial risk for global markets should Iranian sanctions be severely enforced and/or Venezuela collapse. With so much uncertainty with respect to the timing and volume of new oil additions, it is no surprise that, despite the rhetoric and declarations of success in Vienna, oil prices remained bullishly robust (over $74/b Brent this morning).
In the aftermath of the OPEC gathering, there was no shortage of victory statements. With mastery and a touch of ambiguity, Secretary General Barkindo preserved the OPEC framework (and OPEC demonstrated to its detractors that its predicted demise was somewhat premature). President Trump secured his volumetric increase in supply if not a substantial reduction in prices (though NOPEC legislation has been reintroduced in Congress). Iran declared success in holding OPEC members to their previously agreed upon collective commitment. And Saudi Arabia and Russia get to provide additional supply—and realize high prices and increased revenue. Win-win all around.
Proving, apparently, that one can, in fact, have their cake and...well you know the rest.
Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C. Larry Goldstein and Albert Helmig are senior associates with the Energy and National Security Program.
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