Oil prices fell earlier today on the headlines out of St Petersburg from both the Saudi and Russian oil ministers making it clear that adjustments to the 2016 oil output cuts, amounting to as much as 1 million bpd of additional crude supply, are under “active” discussion ahead of the June “OPEC Plus” meeting in Vienna.
There was likewise a headline crossing the wires in the last hour or so hinting at Saudi Arabia resuming the output from the Neutral Zone shared with Kuwait. We would caution that the timing on both fronts will be key.
*** We expect the June 22 OPEC/non-OPEC meeting to formally keep the 2016 oil output cuts in place, as Riyadh sees this hard-won Vienna framework as key to putting in a market floor by making future action on supply restraint more credible and quicker to decide and implement. There will be “flexibility” in the quotas by driving overall compliance down from the current 150% level closer to 100% with a lagged new output largely coming from Saudi Arabia and Russia, with additional barrels from Kuwait and the UAE, through the second half of this year. ***
*** Oil prices are likely to remain volatile in coming weeks, with geopolitical crosscurrents driving headline risk. A bearish supply of extra crude seems likely, and there are questions over just how much in oil exports Iran will lose under the US sanctions. There will be a built-in lagged response in raising actual output this year and there remains a risk of deeper output declines in Venezuela and Libya. Spare capacity will also thin considerably with new output using up most of OPEC’s spare capacity, leaving limited options in response to new supply disruptions. ***
Trump Pressure on Riyadh
As always, Saudi Arabia is key to the OPEC/non-OPEC negotiations and to ensuring a reasonable degree of stability in oil prices — and if things work out, perhaps a gentle rise from current levels. Riyadh is as dependent as ever on a helping hand from Moscow.
With the inventory glut now erased by most measures, Saudi messaging has shifted from “rebalancing” of supply and demand fundamentals towards seeking to allay price volatility. The nuanced shift in policy messaging translates into Riyadh seeking to maximize oil revenue in the near and medium term for budgetary reasons.
The Kingdom faces an unrelenting war in Yemen, limited private sector growth and some degree of capital flight in the wake of renewed politically-driven arrests. Oil price “stability” is also sought to provide the foundations for as high a valuation as possible to the delayed partial IPO of Saudi Aramco, still planned for some time in early 2019.
At the same time, however, Riyadh is anxiously seeking to pre-empt further, more public pressure from the Trump White House to bring oil prices down. Already in recent days, the US media has been highlighting the higher gasoline prices and how it is likely to fully or partially offset the intended gains to spending and demand in the tax cuts.
We in fact understand concerns were conveyed over rising prices for US gasoline to the Saudis in a recent meeting at the State Department.
It would be extremely difficult for Riyadh to ignore the US political pressures to do more than just talking down oil prices when it is so closely aligned with the US, joined by Israel and the UAE, in the Trump Administration’s withdrawal from the Joint Comprehensive Plan of Action, or JCPOA, and the imposition of new, harsh sanctions on Iran.
It is our understanding that Riyadh will try to straddle the two conflicting demands around volatile oil prices in the run-up to the June OPEC/non OPEC meeting with clear indications of its intentions to bring more supply to the market to temper renewed oil price rises, but to do so gradually through the rest of this year to prevent any sharp further falls in oil prices.
Doing so will require close coordination with Moscow — whose oil companies are already intending to increase their output anyway — to support a two-part compromise solution.
Riyadh’s Messy Compromise
The Saudi case is to argue the value in keeping the hard-won Vienna framework in place as a useful mechanism to put a floor under a future oil price decline, but at the same time, to allow for the extra output to soften the hard edge of any further “excessive” oil price increases.
The means to do so is to maintain the Vienna framework but allowing additional output through the mechanism of seeking to lower the overall compliance of the participating member oil producers. That will primarily translate into higher output from Russia, which was essentially coming anyway, some from Kuwait and the UAE, but most of the additional supply coming from Saudi Arabia.
An easing of the cuts would meet the political needs to respond to the US political pressures, but doing so with the Joint Technical Committee monitoring the output and compliance levels, there will be a lagged, more gradual and hopefully more controlled new supply of crude brought to the market.
It may be a messy compromise but the Saudi bet is that it will allow conflicting agendas to co-exist for a while.
For Russia, the process may prove to be relatively straightforward, and in any case, puts it into a position of maximum leverage. Moscow itself has never been as wedded to the Vienna framework as Riyadh, even if the revenue windfall was prized, as is the promised Saudi investments in the Russian energy sector or the benefits of working with the Saudis which consolidated Russia’s emergence in the Mideast as a key power broker.
Russia’s help may also be needed if Iran decides to respond to its impending isolation by trying to block the Saudi proposals within OPEC. Moscow has also been positioning to tie additional crude to temper oil price increases to the fate of the US withdrawal from JCPOA and the sanctions that could limit Iranian oil exports.
This remains a tail risk but with the outcome of the JCPOA still in question and US policy objectives unclear, Tehran’s position within OPEC should not be taken for granted.