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Opec: The rollover

The cuts were extended—but with a built-in escape hatch and implicit threat to other producers

Khalid al-Falih, Saudi Arabia's oil minister, appeared relaxed. A long day of meetings was over and, taking the microphone at the press conference in Vienna on 30 November, he seemed keen to reassert the kingdom's command of the oil market.

Saudi Arabia got what it came for in the Austrian capital at the end of November. But Russia's influence was plain. Opec agreed 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 starts from 1 January 2018 but keeps the cuts, spread across the group and its non-Opec partners, at 1.8m barrels a day. It secures Moscow's cooperation again, dispelling for another few months the doubts that had surfaced about Russia's commitment. But to reach that point, Opec also had to accept the Russian terms, and the detail is in the fine print.

"Supply is going to be fully adhered to," said Saudi oil minister Khalid al-Falih. "We won't expect the surprises, as we saw in 2017." He was referring to the rise in Libyan and Nigerian supply. 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". Since August, the kingdom has sharply reduced its exports, especially to the US.

Falih's words and the show of unity were all bullish. But the big Russian 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 once again, if not before. 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, therefore, a three-month one that will need to be re-confirmed next June. 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 change of tack—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." Plainly, mid-2018 is now a possible end-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.

Opec sources confirmed to Petroleum Economist that the June caveat, and its inclusion in the communiqué, was a condition of Russia's re-commitment to the pact. For all the mood music and the headlines about Saudi leadership, Moscow remains the power behind Opec's throne. The kingdom may bristle at this, but it is jumping to Russia's tune, knowing that without its partner the deal will collapse. Russia's involvement has also been conditional on Opec's full compliance with its own cuts—a reason Saudi Arabia has been willing yet again to do the heavy lifting to compensate for slacker discipline with the cuts from other members. For the price of this influence over Opec, Russia has cut 300,000 b/d of supply from a high baseline last year—a cut of 2.6% compared with Saudi Arabia's 5.6%.

In Vienna, Falih seemed to warn some of the Opec laggards, among them Iraq and the UAE. Although the Saudi oil minister will be stepping down from Opec's rotating presidency at the end of 2017, he will chair the compliance-monitoring committee with Russian energy minister Alexander Novak in 2018. "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.

Sideways prices

Oil prices rose after Opec's meeting on 30 November, trading above $64 a barrel (Brent) and $57/b (WTI). But the momentum was short-lived. Trading was largely sideways in the days afterwards. Brent was threatening to drop below $63/b again on 4 December.

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, reckons $65/b would be too high.

Still, fears of a sell-off was a big motivator for producers at their meeting in Vienna-even those with growth plans for 2018. But another crucial factor was stocks. Falih said half the job had been done, claimed the International Energy Agency's inventory assessment was too bearish and predicted the surplus would continue to shrink in Q2 and Q3 of 2018. The OECD stock excess to the five-year average had fallen from 300m barrels at the start of the year to 140m 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 battle is possible-"well into 2018", according to Falih. 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.

The raw data will also start to confound Opec. Investment bank Barclays reckons that, all being normal, stocks will deplete to the five-year averagebut mainly because the five-year average itself is moving higher. In absolute terms, the bank expects "barely any change" to OECD stocks in 2018.

One tweak that Opec thinks will help was the imposition of a cap on Libyan and Nigerian supply. Strangely, this was only announced by Falih in the press conference, not in the communiqué. Both countries, said sources, had accepted a cap at their 2017 highs. Neither country was likely to breach that level soon. It is understood that the attempt to limit their outputanother Russian stipulationprompted much disagreement in the meeting. For Libya, especially, the cap is a blow. National Oil Corporation continues to work on repairing facilities in the Sirte Basin with a view to increasing output from 1m b/d at present.

Drill, baby, drill

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. Barclays, for example, predicts tight oil output will rise at current prices by 1m b/d in 2018. But if WTI rises another $3/b, to $60, the growth could reach 1.5m b/d. 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 announcedwhile the Opec meeting was still underwaythat US output had risen by 3% in September compared with August, to 9.48m b/d.

And Opec's latest Vienna deal will surely give American producers more faith that the group, wanting to protect recent price gains, will underpin tight oil supply growth and allow them to hedge new output. Opec 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 then, further price strength could also have tempered global demand growth. By then, too, the data will either have confirmed Opec's 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 yet more supply, or ditch its own restraint. Temporary cuts could 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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