A murky crude horizon

Published December 8, 2019
Opec+ has agreed to an output cut of an additional 500,000 barrels per day. — Reuters/File
Opec+ has agreed to an output cut of an additional 500,000 barrels per day. — Reuters/File

With the crude glut just around the corner, the Organisation of Petroleum Exporting Countries (Opec) and its allies agreed last week to one of the deepest output cuts in the decade.

The Opec+ agreed to an output cut of an additional 500,000 barrels per day (bpd) last Friday while Saudi Arabia pledged an additional voluntary cut of 400,000 bpd, taking the total production cut to 2.1 million bpd from the current 1.2m bpd.

How long the cuts would stay in place is not clear. A statement issued by the Opec said, “this additional adjustment would be effective as of 1 January 2020 and is subject to full conformity by every country”.

This means much now depends upon conformity of all to the agreed-upon quotas. Russia, failing to meet its obligations under the previous agreements, got a reprieve, when condensates (a byproduct of gas extraction) were taken out of the overall math. The focus is solely on crude output now.

The announced cut was more than anticipated. Although Jillian Ambrose had indicated in his piece in Guardian, that producers were considering a cut of 800,000 bpd, the rumour mill in Vienna was still underlining a possible output cut of only 200,000 bpd.

The Opec announcement thus had an element of surprise. Prince Abdulaziz bin Salman, on his first outing as the Saudi Petroleum Minister, wanted to give markets a shock too.

“Prince Abdulaziz was deeply concerned about the impression that this would be just a cosmetic cut and wanted to show it was real, credible and would impact the physical market,” Helima Croft at RBC Capital Markets told The Guardian.

Lobbying actively for significant cuts, the prince, known as a tough and shrewd negotiator, upon arrival in Vienna warned, if other countries keep failing to meet their output cut targets, Riyadh could raise output. This would have inundated the markets.

Riyadh prevailed. The ultimate decision went beyond most expectations. But would the additional cuts work? For the oil markets, the new deal would definitely be a psychological boost. And so it was. Prices went up. What next?

Some continue to be unsure. “I doubt this will prevent a fresh build in stockpiles in the first quarter of 2020 as claimed,” Greg Priddy at Stratfor, told Guardian.

And there are reasons for gloom. Saudi Arabia has already been pumping significantly below its quota, and few are likely to believe that countries like Iraq, Nigeria or even Russia, which haven’t complied with the deal so far this year were about to begin complying with. The additional reduction proposed “would actually leave physical production broadly unchanged” because the group is already pumping less than its official target, analysts at Redburn Ltd. said in a note before the meeting.

“Saudi Arabia could easily reduce its official production allowance by 300,000 bpd without affecting its actual production,” Olivier Jakob of the Zurich based Petromatrix Gmbh said. “A cosmetic cut might feed some automated buying on headlines, but that would be a rally, hard to sustain.”

Others including Angola, Iran, Libya, Venezuela, and Mexico have simply been unable to sustain their production due to industry mismanagement, civil war, sanctions or years of under-investment.

“Everyone’s starting to do the math. Between the condensates exemption and the current rate of over compliance, it’s not really a new larger cut,” Again Capital’s John Kilduff told CNBC.

In the meantime, a wave of new oil is set to hit the markets. A slew of new projects, from Norway, Brazil, and the United States, is to get on stream next year.

Crude production from Norway’s Johan Sverdrup field, began ahead of schedule in October, bringing online as much as 660,000 bpd of oil at its peak. In Brazil’s new, pre-salt deposits, oil production is slated to grow by 24 per cent to 3.2m bpd by 2022, reports Wood Mackenzie.

IEA now sees total non-Opec supply expanding by a staggering 2.3m bpd, nearly double the expected increase in demand of 1.2m bpd. Consulting firm Rysad projects oil markets to be oversupplied by about 800,000 bpd during the first half of 2020.

Could the deeper cuts torpedo this looming addition to the non-Opec output? No, it seems. In fact, it could even accelerate the process. And, once dust on the Aramco IPO settles down, Saudi Arabia may not stay keen to balance the markets, as it is today. Market share may go up in Riyadh’s priority list then.

Despite the cuts, the crude horizon continues to stay murky.

Published in Dawn, December 8th, 2019

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