OPEC’s Dilemma—Markets Are Complicated!

Supply, demand, geopolitical events, and sentiment have once again conspired to confuse and complicate The Organization of the Petroleum Exporting Countries’ (OPEC) efforts to achieve and retain acceptable balances in oil markets. Last month’s commentary ( Trump Lambasts OPEC ) identified the wide range of prospective supply and demand-related considerations impacting market balances over the next several months, including increases in oil output from the United States, Saudi Arabia, and Russia, elevated concerns over a global economic slowdown, seasonal adjustments (refinery maintenance and weather), and policy/geopolitics—not the least of which focused on international compliance with recently enacted oil sanctions on Iran. That analysis concluded with the assumption that while markets could tighten during the fourth quarter of this year, surpluses would inevitably return in early 2019.

In the intervening weeks, a number of these events have begun to manifest themselves, some in more predictable ways, others with unintended consequences. Supply has indeed increased with both the Saudis and Russians exceeding expectations and U.S. liquids output is on track to reach 12 million barrels per day (mm/bd) sometime next year. Flows from Iran have decreased, but production from Libya and Nigeria has stabilized, and Iraq is poised to add additional supply once political and logistical issues are addressed. The Trump administration’s announcement (November 5) of waivers/allocations to allow certain nations to continue their purchases of Iranian oil for the next 6 months (more on that later) has also had a profound impact on market sentiment, prompting speculative traders to reposition.

At the same time, projections for global demand growth have been revised downward. Dollar strength and the recent stock market correction have also had a dampening effect. As a consequence, Brent oil prices have plummeted by almost 20 percent.

Against this backdrop, the Joint Ministerial Monitoring Committee (JMMC) met this past weekend in Abu Dhabi to review current market conditions with an eye toward “refreshing” OPEC’s strategy for the upcoming OPEC/non-OPEC meeting next month (December 6 in Vienna). Given evolving market conditions, the group, not surprisingly, discussed the prospect of sizeable (on the order of up to 1 mm/bd) output cuts and the “refresh” is likely to embody an updated narrative emphasizing OPEC’s view that the current market appears to be adequately supplied while pledging to monitor and adjust as necessary to retain that delicate balance going forward.

Complicating those discussions, however, would be the basis on which new cuts might be allocated among members. Saudi Minister al-Falih has already indicated that Aramco has seen a substantial (500 m/bd) reduction in nominations for December, though earlier price increases could account for at least part of that demand drop. And while it’s possible that reductions could be extracted from those producers who have recently increased output since this summer’s agreement or by requiring concessions from previously exempt members, it is unclear how consensus might be realized under various formulas. The threat of NOPEC legislation in face of a newly-elected Democratic House and President Trump’s opposition to higher oil prices ( his tweet on November 12 urged the Saudis/OPEC to refrain from additional cuts), the continued fallout from Jamal Khashoggi’s death, and the speed at which Iran sanctions remove additional barrels from the market add to the complexity and intrigue.

With respect to the sanctions impact, while the administration may have sought to prudently apply a more gradual reduction of Iranian oil sales in order to prevent a near-term spike in oil prices, and “benefit” from a projected surplus in 2019 to ratchet down the next round of allocations/waivers, the 180-day extension/review period (to May of next year) could actually come precisely at a time when demand is poised to accelerate. And given that the United States is now a major producer as well as consumer, volatile prices can also have an adverse impact on domestic supply growth.

All that said, we suspect that the outcome of the upcoming OPEC meeting is more likely than not to result in a net reduction (formal or informal) of the aggregate supply provided by alliance members in order to forestall the recreation of another inventory buildup over the next several months. We would also expect that the much-anticipated resumption of joint Saudi-Kuwaiti production from the shared Neutral Zone is also likely to be delayed, but, as always, caution that politics often transcends rational analysis.

Frank Verrastro is senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS). Kevin Book and Larry Goldstein are non-resident senior associates with the CSIS Energy and National Security Program.

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