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Opec's rollover: market tweaking in the hands of Saudi Arabia

Opec maintained its target ceiling, and the market barely reacted

The market is "adequately supplied", slower growth in the Chinese economy is of no concern and the rise of shale oil in the US poses no threat to Opec's producers, said its secretary general on 31 May, as the group rolled over its existing 30 million barrel a day (b/d) production ceiling. 

Analysts and Opec watchers expected the decision to keep the ceiling target unchanged, and the market barely reacted. Front-month Brent was soft on 31 May, selling for around $101.50 a barrel.

Opec chief Abdalla El-Badri said the "relatively stability of prices" indicated that the market was well balanced. Members "should adhere to the existing ceiling", he said, but some of them "would, if required, take steps to ensure market balance".

That is code for Saudi Arabia, with a little help from its Gulf neighbours. The kingdom's strategy in the past year has been to trim or add supply depending on market conditions. This is how Opec will manage the coming months when, notwithstanding the expected seasonal rise in consumption, bigger supply and demand issues may come to the fore.

These Saudi tactics have been in play for over a year. After pumping more than 9.7m b/d in the third quarter of 2012, pushing Opec's total to 31.2m b/d, the kingdom's supply dipped to just over 9.1m b/d in the first quarter of this year, reflecting weakness in demand. Opec's output in that quarter fell to 30.2m b/d, or just 200,000 b/d above the target.

The coming months will probably need more tweaking from Saudi Arabia, if prices are to remain around $100/b - Opec's de facto price target. The kingdom's output in April was just shy of 9.3m b/d. Opec's was close to 30.5m b/d. El-Badri said in Vienna that the call on the group's crude was expected to be 30.4m b/d in Q3 - meaning the market will tighten again unless production rises - and fall back to around 30.1m b/d in the fourth quarter.

But as Saudi Arabia, the only member with significant capacity to lift and lower its output as needed, tries to keep the market in what oil minister Ali Naimi says is the "best environment", Opec faces a slew of other issues that could upset the balance.

Supply-side risks within the group are one reason why Opec cannot talk of cuts right now. Iraq, Libya, Iran, and Nigeria are all either struggling to maintain output in the face of political problems, or already shedding capacity.

Iraq's oil minister, Abdul Karim Luaibi, told Petroleum Economist that his country would increase output this year from around 3.1m b/d in April to 3.4m b/d or 3.5m b/d.

In the interview, he also claimed Baghdad had an agreement in place with the Kurdistan Regional Government (KRG) that would mean exports of 250,000 b/d would begin flowing through the federal government-controlled Kirkuk-to-Ceyhan pipeline.

Luaibi also said production in the south remained insulated from the civil strife in Iraq that killed more than 500 people in May. And he brushed aside the repeated bombings of the Kirkuk pipeline in recent weeks.

But analysts do not share his optimism. Iraq's production growth had slowed in recent months, after reaching more than 3m b/d last year. Terrorist threats to oil infrastructure in the south were now a major risk to further growth this year, said one analyst.

A source close to the KRG's oil ministry also denied to Petroleum Economist that an agreement was in place for exports, saying the only deal on the table was one from September 2012, which Baghdad had reneged on last year.

Nigeria's output is struggling to stay above 1.7m b/d, and fell by another 12% between March and April. In the US Congress, there are calls for fresh, tighter sanctions against Iran's oil sector. Libya's output, claimed by state-controlled National Oil Company to be around 1.6m b/d in April (Opec says it was less), is also under pressure amid political chaos in the country and the lack of well maintenance.

With these worries in the backdrop, Opec is in no position to take on voluntary cuts, given concerns that a run-up in prices could exacerbate global economic weakness and hurt demand for its oil.

Opec expects consumption to rise in 2013 by 800,000 b/d, demand growth that remains at about half the pre-financial crisis pace.

A recent slowdown in China's economy was of particular concern to the group, said insiders, given Opec's expectation that all of the extra oil needed by the world this year would be consumed in Asia.

An official told Petroleum Economist that Opec was preparing an internal report on demand, especially in the transportation sector, amid concerns about trends in fuel economy. "If transportation goes, that's massive for Opec," said the official.

Officially, Opec tried to dismiss fears about China's economy and its impact on demand for the group's oil. China's economic growth would "always be between 7% and 8%," said El-Badri. "I'm not worried about China."

On 29 May, the IMF downgraded its forecast for Chinese growth, saying its economy would now grow this year by 7.75%. China's own data recently showed its economy growing by 7.7%. The IMF said too much GDP growth in China depended on investment, especially in the property sector.

Continued demand from China will be crucial to Opec because the world's biggest oil consumer, the US, is rapidly weening itself off the group's oil. In March, US imports from Opec amounted to 3.7m b/d, according to the Energy Informational Administration (EIA). In 2007, it imported almost 6m b/d from the group.

But Opec's view of rising US shale- and tight-oil production, which has taken the country's output to decade highs, was just as sanguine as its view of China's economy.

Saudi Arabia's Naimi said the world was paying too much attention to the new production from North America. "It's not the first time new oil has been discovered in the world," he told reporters. "Why are you all so excited?" There had been too much "chit chat" about shale oil, he added.

El-Badri said there were many uncertainties about shale oil. "To drill a well you need $120 a barrel," he said. Decline rates in shale-oil wells were 60% in the first year, he added. "For that reason we need to look into the accurate numbers. How much is sustainable?"

Reuters news agency last year estimated break-even costs for wells in the Bakken shale to be $55-70/b. Producers in Canada's oil sands say their production remains viable at prices as low as $35/b.

In any event, new oil output from the US would not be enough to disturb Opec's market share, suggested the secretary general. "The EIA figures are saying production will be 4m to 5m b/d by 2035," he said. "If that's the number, it won't impact our member countries."

The International Enegy Agency said in its Medium Term Oil Market report that the "shockwaves from rising US shale gas and light tight oil and Canadian oil-sands production are reaching virtually all recesses of the global oil market". 

Some analysts suggested Opec was ignoring fundamental threats to its role in the oil market. An official in the group conceded this, saying Opec was typically reactive, not proactive. "We don't do contingency planning."

It should probably start. Neil Atkinson, director of energy analysis at Datamonitor, pointed to similarities between the state of the market now and the mid-1980s, when oil prices plummeted and remained weak until the first Gulf war.

In the mid-1980s, said Atkinson, Opec also discounted the arrival of new output from the North Sea. Demand was also under pressure, too. Having produced 9.9m b/d in 1980, Saudi Arabia's output fell to an average of 3.4m b/d in 1985, as a glut of supply combined with falling demand.

That prospect may remain unlikely now, but sentiment has changed. In recent Opec meetings, no one has talked seriously of a slump in oil prices. Now such chatter is commonplace among seasoned Opec watchers.

Other imminent bearish forces are out of Opec's control. An end to the Federal Reserve's bond buying programme, say analysts, will hit oil prices. Compared to other commodity prices, which been falling in recent months, oil has remained relatively robust.

El-Badri downplayed that threat, too. The risk of the Fed's quantitative easing programme ending are "not only for us, but also for the US economy", he said. But, shrugging his shoulders, he refused to speculate on when the bank could remove this pillar of support for oil prices. "The Fed is the Fed," he said.

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