OPEC: A Deal Taking Shape

Published on June 20, 2018

With the formal OPEC+ meeting still a few days away, most of the energy officials are already in Vienna and engaged in countless bilateral meetings. OPEC Secretary General Mohammed Barkindo, in particular, has been busy in keeping a deal on track amid the cacophony of competing and contrasting positions laid out in media briefings.

*** With the caveat that things could always still derail, we believe there will be a deal on Friday to roll over the existing Vienna agreement but allowing for additional supply. Although the actual numbers will not be cited in the communique, we understand the agreement will translate into an increase in OPEC+ output by as much as 700,000 to 800,000 bpd, mostly from Russia, Saudi Arabia, Kuwait, and the UAE. Other members who can will be free to add to the mix. ***

*** The key to this art of the deal OPEC-style will be “compliance.” In order to ensure both additional supply while maintaining the 2016 Vienna framework — a key redline demand of the Saudis — the additional crude will come to market as needed to bring OPEC+ compliance to the current quotas down to 100% from the 160% in May. The extra output could come in stages, or be lagged into after the OPEC+ monitoring process. ***

*** There is a decent risk the extra supply could be entirely offset by further losses in output by Libya and Venezuela. We understand the new risk to Libyan output may be cited as a justification for the higher output. The uncertainty over output may lead also lead to a call in the OPEC+ communique for an extraordinary meeting in September, to assess the “supply and demand balance,” in the run up to the annual November ministerial meeting. ***

Art of the Deal, OPEC Style

In the last few days as the energy delegations made their way to Vienna, the principle of additional supply was pretty much already reached, despite some of the fierce protests of the Iranians and Venezuelans refusing to concede any extra crude supply if it was driven by the political demands of US President Donald Trump.

The expected total amount of additional crude supply will still be on the table, also to be finalized in the formal meeting on Friday. The range of estimates going into the meeting range from a low of no more than 600,000 bpd (and even as low as 300,000 bpd at one point) hinted at by the Saudis to as much as the 1.5 million bpd floated by the Russians.

There has been some confusion in the media that the higher output is jointly being pushed by the Saudis and the Russians. But that is not quite true. The Saudis are only very reluctantly agreeing to the additional supply now instead of perhaps later, primarily because the Russians left them no choice.

The Russians were already increasing their output and made every indication to their energy counterparts in the Kingdom and the UAE that the Russian companies will be increasing their output by at least 300,000 bpd as soon as they can lift it and find the customers to buy it.

For the Saudis, maintaining the Vienna framework of quotas and the crucial monitoring mechanisms was an essential strategic objective, seen as a potential floor mechanism to rapidly put in place if, and when, oil prices ever plummet again.

To save the hard-found November 2016 agreement, they conceded the need to increase supply — their decision helped by President Trump’s tweets and in meetings between the US State Department and the Saudi Foreign Ministry (SGH 6/5/18, “OPEC: More Crude, But Lagged”) — but they have been looking ever since for a way to do so that would avoid a formal policy change, or renegotiating an entire new set of quotas.

The solution was the compliance hook: to set the terms for the additional supply as a response to the excessive compliance to date due to the quota shortfalls by Venezuela and a few other participants, and to bring the unintended excessive compliance down to a mere 100%. Thus, the Russians additional output already will be messaged as coming under the terms of the agreement to bring the compliance down.

The Saudis have also begun lifting their output, albeit more gingerly, and the additional output from the Saudis and the GCC producers may only come more gradually in the coming months, perhaps using the monitoring process as the vehicle to lag the new supply.

And while Iran was widely expected to be the most likely spoiler to an agreement, they have come round to the compliance vehicle just in the last 24 hours. This was apparently the result of the diplomatic work by OPEC Secretary Barkindo, who convinced them that fundamentals, not President Trump, in an expected rising demand through next year and the shortfalls in intended output, were the reasons for needing more supply.

So while Iran and Venezuela, whose influence rides entirely on their status as founding members and the tradition of consensus agreements, could still resist the final terms to the agreement that seems to be taking shape, we would make it a tail risk at most at this point.

Lower Libyan Output Risk

Another factor easing the way for the carefully crafted agreement for higher output is apparently the concerns that Libyan output may be falling soon, perhaps by another 300,000 bpd on top of the near 400,000 bpd in lower output in recent months. That risk is what seems to have moved the Saudis off their intended, initial proposal for no more than a 300,000 bpd increase as well as moving the Iranians off their initial zero output increase stance of just a few days ago.

We doubt any of these numbers will ever make their way into the official communique that will instead highlight how the decision was entirely apolitical and driven by supply and demand fundamentals. The numbers will instead be messaged on the sidelines and perhaps in the post-meeting presser.

Keeping an official ambiguity allows OPEC+ to avoid a messy revision to the original November 2016 agreement, or to define which countries are allowed higher quotas, and to meet the demands by both Russia and Trump for more crude supply. Central bankers would call this “constructive ambiguity,” and OPEC is readily grabbing at just that.

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