OPEC: Tolerating an Overshoot

Published on January 17, 2018

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.

A couple of points:

** Saudi oil officials 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 output cuts are only now starting to drain away some of the global supply surplus.

** There is no chance of changes to the formal quotas and agreed upon output cuts before the June 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 million 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 meeting than June.

** Officials will start discussing the early outlines of a mechanism to a gradual exit from the Vienna output deal at the Ministerial Monitoring Committee meeting in Oman this coming Sunday, but only informally. Saudi energy minister Khaled al-Falih will meet with his Russian counterpart, Alexander Novak, on the sidelines, to discuss areas of Saudi-Russian oil policy cooperation.

** Cheating on current quotas by some participating oil producing countries in the Vienna agreement seems inevitable, high on list being Iran, to get in front of potential new sanctions, and Iraq. 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.

** Russian oil companies are clamoring to be released from their output constraints before year-end, but for now Riyadh 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.

** It is noteworthy that Saudi Arabia’s FY2018 budget is based on a $60 crude oil price, and that it included a significant boost to social spending to help dampen political discontent over the recent economic downturn and dearth of jobs for young Saudis. The Saudi Aramco IPO, targeted for year-end 2018 or early 2019, is likewise assuming a $60 a barrel oil price.

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