The nightmare for OPEC oil producers and those that joined them in the production cut agreements in November 2016 is that high oil prices are a blessing and a curse. The blessing is obvious – many are still fiscally stressed and need high oil revenues to sustain their oil dependent economies until they can start a meaningful transformation and diversify their economies away from oil.
That will take time and in the short term they have to wrestle with policy decisions on whether to continue with their production cuts, drain away surplus oil inventories but at the same time see non participating oil producers, whether states or individual shale companies in the USA, come back with a vengeance and pump more oil and take up market share lost to those in the agreement club.
It is a fine tuned balancing act and, as the Saudi Oil Minister Khaled Al Falih recently said at the Davos World Economic Forum, there is still some way to go before some sort of stability in global supply and demand can be reached and the the current OPEC- non OPEC agreement will continue in one form or another into 2109. Some are now predicting that this agreement will take a life of its own and continue well past 2019 but metamorphose into some other energy – economic strategic partnership nexus, especially between the two heavyweights in the agreement, Saudi Arabia and Russia.
In the meantime, OPEC officials sound like central bankers these days, referring to a $60 "equilibrium" crude oil price and referring to the long period of "undershooting" that equilibrium price when pushing back on whether there might be a policy response any time soon to spot oil prices reaching up into a $63 to $70 range. Some OPEC states, especially those in the Gulf, are for now quite willing to tolerate a crude oil "overshoot" of the $60 target price. Crude prices have only recently risen above the $60 mark, making it "premature" to talk about adjustments to the current quota framework. The reason is simple - the output cuts are only now starting to drain away some of the global supply surplus although the various estimates from OPEC and the International Energy Agency differ.
For the time being, there is no chance of changes to the formal quotas and agreed upon output cuts before the June 2018 Ministerial meeting. Extensive negotiations will be needed to work out what the OPEC officials suggest will be a quarterly, possibly monthly, "reverse taper" in which participating oil producers will be allowed to gradually increase their output under a formula still to be worked out. Key to its success would be what is understood to be a Saudi willingness to assume a "first in/last out" role in the reverse taper, that is, just as it front-loaded the bulk of the output cuts that led to the November 2014 Vienna agreement, it will likewise be the last of the 24 agreement participants to fully recover its output cuts. The objective is to bring OECD crude inventories, now at around 2.91 billion barrels, to their five-year historical average of 2.73 billion barrels, and which is likely to require a six-month assessment period to gauge to what degree prices are in line with demand and consumption trends. That would put any changes in the quotas closer to the November 2018 meeting than June.
The headache until then is to continue instilling discipline amongst countries that see the current high oil prices as a bonanza and cheat on their quotas, especially from Iran which is fearful of more economic sanctions, putting the agreement into jeopardy and another free for all market share rush. But whatever cheating there may be is likely to be offset by falling output from other oil producers such as Libya or Nigeria, and especially Venezuela. If this happens, then Russian oil company incentive to remain in the pact will be sorely tested as Russian oil companies are clamouring to be released from their output constraints before year-end, but for now Saudi Arabia especially is confident Russia President Vladimir Putin will enforce Russia's agreed 300,000 bpd cuts in output until the details are worked out for an agreement to the envisioned gradual "reverse taper" of the existing quotas.
The headache for those in the agreement is that current high oil prices will once again bring out the cat in the bag, the U.S shale producers, as well as Canadian and Brazilian production, with estimates of another 1.1 million barrels per day of U.S. shale alone coming into the market in 2018. Some believe that this is a blessing in disguise as too high prices – once again going north of $ 80 per barrel – might cause global economic growth to slow, and kill off incremental oil demand. So next time you see oil prices reach such levels, take pity on those oil producers in the Vienna agreement trying to juggle their desire for high oil prices, but not too much please…
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co author of ‘OPEC in a Post Shale world – where to next?’ His latest book is on ‘Saudi Aramco 2030: Post IPO challenges.’