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Opec and non-Opec agree a rollover, with caveats

Cuts extended to end-2018, but with a built-in escape hatch—and an implicit threat to other producers

Saudi Arabia got what it came for in Vienna on 30 November—a nine-month extension to the cuts that would otherwise have expired in Q2 2018. It forced Libya and Nigeria to accept a cap on output. The revised deal will start from 1 January 2018 and remains a total removal of 1.8m b/d of supply from Opec and non-Opec. It secures Moscow's cooperation again, dispelling for another few months the doubts that had surfaced about Russia's commitment.

"Supply is going to be fully adhered to," said Saudi oil minister Khalid al-Falih in the press conference after the meeting. "We won't expect the surprises, as we saw in 2017." Asked if the kingdom would be prepared to cut more deeply in 2018 to speed the market's rebalancing, Falih said "yes", and added later that "2018 would mirror what we have done in 2017".

That sounded bullish—but the big caveat in the deal is obvious. Opec and its non-Opec partners will officially review the cuts in June 2018, meaning the extension question will arise then yet again. Opec will look at the "supply, demand and inventory" data, said Falih. "If one of the variables diverts significantly from where they need to be, we will consider them."

A deal dressed as a nine-month extension to go on after the original expiry of March 2018 is, in effect, a three-month one.

The plan for a review in June was a concession to a growing band of cut-sceptics, including Russia, where producers had questioned the need to keep cutting and worried that further price strength would spark a supply reaction from US shale. Assuming prices remain firm, as Opec wishes, the market will know by June just how much more oil the US is adding to supply—and just how big a hit the rebalancing effort has sustained.

At that point, it seems Opec would consider a different kind of reaction—a hint of more supply. The official statement after the meeting implied Opec could exit the deal earlier if the market overheats. "It is intended that in June 2018 the opportunity of further adjustment actions will be considered based on prevailing market conditions and the progress achieved towards re-balancing of the oil market at that time." The June review now stands as a possible break-point in the cuts. "We as a grouping will be agile, on our toes, and react and respond depending how events may unfold," said Falih.

Falih also issued a veiled warning to fellow producers within Opec that have exceeded quotas during 2017, among them Iraq and the UAE. The Saudi oil minister will be stepping down from Opec's rotating presidency at the end of 2017, but will be chairing the compliance-monitoring committee with Russian energy minister Alexander Novak next year. "I'm going to be breathing down the necks of the other 24 countries making sure that everybody stays the course," he said, referring also to the signatories to the pact that includes non-Opec producers.

Price support

Oil prices rose while Opec ministers met on the morning of 30 November, supported by newswire flashes confirming the deal. Brent traded above $64 a barrel before falling to $63.40 at 1900 GMT. WTI traded lower after the meeting ended, to $57/b.

Keeping the price above $60 a barrel is now Opec's undeclared aim. Some members were happy to acknowledge that. Iran's oil minister, Bijan Namdar Zanganeh, told journalists most Opec producers now wanted $60-65/b—a price he said would not trigger too great a supply response from the US. An exception is Iraq, which has been a reluctant participant in the cuts. Its oil minister, Jabar al-Luiabi, reckoned $65/b would be too high.

Still, fear of a sell-off was a big motivator for producers—even those with growth plans for 2018 and those that expressed reluctance to keep cutting—as they agreed to an extension. But another crucial factor was stocks. Falih expressed his satisfaction with progress on efforts to bring down the inventory, saying half the job had been done. He claimed the International Energy Agency's assessment of stocks was too bearish and predicted they would continue to shrink in Q2 and Q3 of 2018. The OECD surplus had fallen from 300m barrels at the start of the year to 154m in October, according to Opec.

That is progress—but not at the pace Opec originally envisaged when it started cutting. Its deal started as a short, sharp six-month effort to eliminate the overhang. It expected it to be gone by now. Many analysts agreed. Yet it lingers on, and the plan to extend the cuts to end-2018 suggests Opec thinks another year of the excess is possible. Falih says the stocks battle could go on "well into 2018". This also needs compliance to remain as high as it did in 2017—an act of faith, given the reluctance of some cutters in the run-up to this meeting to endorse the extension.

One tweak that Opec thinks will help speed the clearing process was the imposition of a cap on Libyan and Nigerian supply, without specifying the limits. Both countries accepted a cap at their 2017 highs. Neither country was expected to exceed these levels by much in the short term anyway.

Shale reaction

The deal now awaits the response from tight oil. Opec, with a poor recent history of forecasting the American shale sector, could get things very wrong. It expects tight oil production to rise by just 0.62m b/d in 2018. Kuwait's oil minister said it might be 0.7m b/d. If these kinds of numbers hold, rising global demand next year (Opec expects another 1.5m b/d of growth) would help the group engineer a soft exit from the cuts, probably in the second half of 2018.

But tight oil's response at $65/b, Brent's price after the Opec announcement, could be much higher than the group thinks. Investment bank Barclays, for example, predicts 1.5m b/d of additional US tight oil supply in 2018 at that price. On its own—without accounting for supply growth from Brazil, Canada, Kazakhstan and others, or some leakage from Opec itself—the US would therefore match expected global oil-demand growth. Stocks would rise again. Prices would fall.

As if to confirm the problem, the Energy Information Administration announced—while the Opec meeting was still underway—that US output had risen by 3% in September compared with August, to 9.48m b/d.

The news from Vienna will surely give American producers more faith that Opec, wanting to protect recent price gains, will underpin new tight oil supply growth, and allow them to hedge new output. Opec, enjoying $60-plus oil, clearly doubts these producers' ability to do much damage to balances: 2018 will decide who is right.

It means Opec could face another dilemma next June, by which point the data will have confirmed its tight oil scepticism or blown it out of the water. If it's the second outcome, the group has a difficult choice. Keep cutting to prop up prices and accommodate the new supply, or ditch its supply restraint. The temporary cuts would start to look like perma-cuts. Persuading Russia and others to keep sacrificing output will be an even bigger job for Saudi Arabia next time around.

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