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The cuts deal is central to Opec’s branding under secretary-general Mohammad Barkindo
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Opec's next balancing act

The oil market is at a crux point as bullish and bearish forces battle to set the tone

After a long hot afternoon around a circular table in Algeria, Opec struck its deal with Russia to start cutting oil production. It was September 2016 and the agreement-the "Algiers Accord", as Opec now styles it—was the beginning of the end of the oil-price slump.

The partners will ride back into Algiers again in the final week of September to honour the date. The deal has become central to Opec's branding under secretary-general Mohammad Barkindo. Celebrations are planned. The cutters have every reason to be pleased. The supply glut has been gone now for months. A barrel of Brent crude oil, about $55 two years ago, has traded above $70/b since mid-April 2018. Saudi Arabia is said to want to maintain a price band of $70-80/b. Opec and its partners are on a good run.

But the market is entering a tricky phase—and the group must now step carefully. Many investment banks and other analysts are sticking to price forecasts that see Brent hovering this year and next within the Saudis' range and roughly in line with the forward curve. But the consensus belies the uncertainty. The market's direction is once again now hard to call.

Bully for you

Start with the bullish case and start with Iran. Even before the US sanctions officially resume, on 4 November, Iranian exports have been in freefall. In April—before Donald Trump announced he was ditching the nuclear deal—they stood at 2.4m barrels a day. In August, they were down to 1.9m. Europe, not including Turkey, bought 510,000 b/d of this, according to the International Energy Agency—but its imports will probably be nil by the end of 2018.

No one, including US administration officials, can say how low Iran's exports will fall—this is one of several uncertainties in the market. But it looks increasingly likely that Trump's sanctions will be harsher than Obama's, which were carefully calibrated to remove just enough (around 1m b/d) to hurt Tehran without spiking oil prices into a range that would compensate Iran for the loss. That involved offering a string of waivers to importers of Iranian oil.

The US looks much less congenial this time around. Secretary of State Mike Pompeo was in India, a crucial destination for Iranian oil, in early September to squeeze New Delhi to cooperate—apparently in exchange for the US agreeing to India's purchase of air-defence systems from Russia (also under US sanctions). "We're asking all of our partners, not just India, to reduce to zero oil imports from Iran," an unnamed State Department official was quoted as saying.

Even before he went, India's Iranian oil purchases were down by 380,000 b/d in August compared with July, according to the IEA. China's were also down (by 200,000 b/d)—though Beijing will be tougher to cajole into an even sharper reduction.

Venezuela's decline remains the other potentially overwhelming bullish force. Output was 1.22m b/d in August, according to pricing agency Platts, a 680,000-b/d drop since the start of the year. An exodus of skilled workers, difficulties sourcing diluent for use in Orinoco extra-heavy oil production, the collapse of investment to sustain mature fields, currency devaluation, hyper-inflation and a spiralling debt crisis: the Venezuelan vortex appears irreversible in the short term. Output could easily slump beneath 1m b/d in the coming months.

Libya's oil-production recovery since July—about 300,000 b/d to just under 1m b/d—means its risks are now once again to the downside. A terrorist attack on 10 September at the National Oil Corporation headquarters in Tripoli killed two men (and three suicide bombers). Mustafa Sanalla, who was in the building at the time, mercifully survived. The assault was symbolic of the country's political disarray and capped a fortnight of militia violence in the capital. Yet the more serious threat to output still stems from groups said to be amassing fighters to make yet another attempt to capture the prolific oil crescent in the centre of the country. At least 500,000 b/d of Libyan output must be considered almost permanently at risk.

Supply problems aren't just restricted to Opec's geopolitical basket cases. In early September, the US' Energy Information Administration lowered its forecast for American crude oil output in 2019 by 200,000 b/d to 11.5m b/d. Halliburton's chief executive said "budget exhaustion and [lack of] takeaway capacity" in the Permian was behind a slowdown among his clients in the tight oil sector. This will last until new pipes are installed next year. Still, it's oil the market was expecting that won't appear.

All of this—less growth from the US, much less oil from Iran and Venezuela, the security vacuum in Libya, and even less-noticed problems like the protests around Basra, in Iraq—suggests that Opec may need to pump more oil if it truly wants to prevent a price surge above $80/b. Two problems stand in the way.

First, is whether Opec has much more oil to offer. After the group's meeting in Vienna in late June, when it effectively ended the cuts, Donald Trump tweeted that he had asked Saudi Arabia to increase output to 12m b/d. The kingdom wouldn't go that far, but its officials briefed that production would reach record highs near 11m b/d. It hasn't. In July it was 10.35m and in August 10.42m b/d, according to the IEA.

Between them, the core Opec members (Saudi Arabia, Kuwait and the UAE) pumped 16.2m b/d in August, according to Opec, about 600,000 b/d more than in May. That's less than the Saudis on their own promised; less than has been lost from Venezuela since January; and barely enough to cover the decline in Iranian exports in the past three months. And much of this extra Gulf oil was burnt in local power stations to keep the air conditioners on. The suspicion in the market is that there isn't a great deal more oil to come.

Something for bears

The second problem is that, notwithstanding the abundant supply risks, market balances in 2019 are starting to look weak again—and if Opec ministers read their own Secretariat outlook less oil, not more, is necessary.

Although it only modestly trimmed its global demand-growth forecasts for 2018 and 2019 (to 1.62m and 1.41m b/d, respectively), the Secretariat's most recent market commentary noted the "underlying fragility" of the economic outlook, in which risks were now "more skewed to the downside". Trump's trade wars, monetary tightening and currency weakness in emerging markets may all affect consumption. Don't be surprised if the demand outlook is adjusted lower soon.

Opec's forecasts for production from outside the group were also bearish. Last November, Opec predicted non-Opec supply would rise by 870,000 b/d in 2018. Now it expects the number to be more than 2m b/d, both this year and next. This means that, in 2019, demand for Opec's own crude will fall, year-on-year, by about 900,000 b/d, according to the Secretariat.

But the details are devilish. In the first quarter of 2019, demand for Opec's crude, the group believes, will be just 31.8m b/d-almost 800,000 b/d beneath current production. On the other hand, in the fourth quarter of this year, demand for its oil (33.6m b/d) will be 1m above current production (see table).

So what gives? To meet the fourth quarter needs and plug any gaps from Iran, Venezuela and others, Opec must pump more oil and fast-if it can-or risk a short-term price surge that will worsen its already-nervous demand outlook. But to prevent another stock build and price slump starting again in 2019, it should be resurrecting the cuts programme again in Algiers.

That would be difficult—especially as Russian producers, so critical to the agreement last time, are now ramping up their own supply. Likeliest is that Opec will do nothing now and wait to see which disrupts balances more severely: the coming Iran sanctions or the coming trade wars and gathering macroeconomic headwinds.

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