OPEC’s Easy Win Masks Tougher Oil-Market Choices Still to Come

The group of oil nations agreed to extend year-old production cuts through the end of 2018 to help boost prices, no small achievement. Yet as smooth as the gathering seemed to go, the deal actually left all the big questions unanswered, meaning that the real drama will commence next year. If the cuts succeed in meeting their stated goal of bringing global inventories back down to their five-year average level, how will the deal be unwound? And if they don’t, will the deal be extended in perpetuity?

 Along with the growing global economy, the production cuts have helped push up oil prices. But that has left OPEC and its allies with a quandary: How to keep prices high without stimulating further growth in U.S. shale oil production. “OPEC is between the devil and the deep blue sea,” said David Fyfe, head of market research and analysis at Geneva-based commodities trader Gunvor Group Ltd. Khalid Al-Falih, Saudi Arabia’s energy minister and OPEC’s most powerful member, acknowledged a “number of variables that we cannot fix with certainty going into the new year.”

Shale Production

By pushing prices to their highest level in more than two years, with benchmark Brent trading above $63 a barrel, the cuts have allowed shale producers to lock in margins and plan new investments.In a sign of the challenges that OPEC faces, the U.S. government reported a large increase in domestic production in September, bringing the total to 9.48 million barrels a day, the fourth highest monthly level since the early 1970s. Oil output surged in Texas and New Mexico, home of the prolific Permian shale basin.

Al-Falih professed to be unconcerned by the growth in shale output. “The contribution of shale in 2017 is going to be very much manageable,” he said. “My expectation is that 2018 will not be significantly different from 2017.” It’s not just shale output that’s turning a corner. After two years of cutbacks and deleveraging, oil majors are beginning to regain their swagger. Royal Dutch Shell Plc this week said it would stop paying dividends in shares for the first time since 2015. Exxon Mobil Corp. started production at the Hebron field off the coast of Canada.

 

United Front

For now, though, the signatories, especially Saudi Arabia and Russia, presented a united front, contrary to Wall Street banks such as Goldman Sachs Group Inc. and Citigroup Inc., which had bet that Moscow would sink any deal.  “You can’t find light between us, we have been united shoulder-to-shoulder,” Al-Falih said, referring to Russian counterpart Alexander Novak. Or as Jamie Webster, an OPEC watcher at the Boston Consulting Group, put it, “For now, the OPEC-Russia bromance continues.”

What’s more, Libya and Nigeria, which had been exempt from the deal, agreed not to lift production above their peak 2017 levels. While saying he was “very bullish” about oil demand for next year, Al-Falih said the group had not yet defined exactly when it would start unwinding the cuts, or how.

 

June Meeting

Novak suggested that the next OPEC meeting, in June, might be a time when the group could consider adjustments to the deal if needed. Both men pointed to the level of inventories as a key indicator for the producers’ group — but they didn’t say which data they would use as a benchmark, nor exactly what their target would be.

“It’s way premature to design the exit strategy,” said Al-Falih. “As I mentioned we have upwards of 150 million barrels of inventories to draw.”

All that means that 2018 is likely to be the year of fireworks for the deal, when Russia and Saudi Arabia’s new-found cooperation in oil markets will either be proved a resounding success or be put to the test.

“Next year will mark the peak of U.S. shale annual growth,” said Ann-Louise Hittle, vice-president at consultant Wood Mackenzie Ltd. in Boston. “If OPEC can go through 2018, then they will have weathered the storm.”

Sources: Bloomberg with assistance by Grant Smith, Julian Lee, Angelina Rascouet, Wael Mahdi, Elena Mazneva, Golnar Motevalli, Nayla Razzouk, Laura Hurst, and Salma El Wardany