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Opec's 2019 dilemma

The cartel faces unprecedented challenges, amid sceptism that output cuts will avert a global supply glut

Bearish voices are loudest these days. Several big houses have downgraded their 2019 price forecasts: Goldman Sachs has gone from $70/bl to $62.50/bl, citing a surge in production, particularly from US shale.

Opec may be less influential than it used to be, but still accounts for more than 40pc of global oil supplies against 53pc in the 1970s. Clearly, it has more clout when acting as Opec+, the wider cartel that includes Russia and Kazakhstan—which struck a supply cuts accord in Vienna in December.

Despite Opec's heft, with mega-producer Saudi Arabia at the helm, undercurrents in the global energy marketplace are viewed as unsettling.

Garbis Iradian, chief economist for the Mena region at Washington-based Institute of International Finance (IIF), says the shale revolution means "we will never see Brent oil above $65/bl on a sustained basis of time in the medium term—say from 2019 to 2025".

Bob McNally, head of Rapidan Energy Group and a former adviser to President George W Bush, says "the cuts Opec have put in place fall far short of what is needed to prevent huge global surpluses, like over 1mn bl/d, in the first half of this year."

For Saudi Arabia, Opec's largest and most influential producer, a Brent price in the mid-sixties is a challenge. For Riyadh, the fiscal break-even for Brent—one which balances Riyadh's 2019 budget—is around $90/bl, according to Iradian, although others have put that number in the low-to-mid-80s, or even lower.

Low price risk

At $65/bl, the IIF's average price forecast for 2019, Saudi Arabia's fiscal deficit would hit about 7pc of GDP, says Iradian. But a deficit of that size could easily be financed by tapping the international market and issuing domestic debt, given the kingdom's low public indebtedness.

The main risk to the outlook is much lower oil prices, say less than $50/bl for Brent. If oil prices remained below that level for several years, then Saudi Arabia's public debt could rise to over 50pc of GDP by 2022, says Iradian. That would seriously undermine the government's determination to stimulate public and private investment to diversify the economy away from oil, providing much needed employment for its burgeoning and youthful population.

1.2mn bl/d—Opec+ agreed to cut at the December meeting

Despite the recent tick-up in the oil price, McNally says the near-term signs for the market are ominous as "a supply tsunami is building". As well as insufficient cuts and strong US shale output, McNally cites production increases in Iraq, and an anticipated splurge from non-Opec member, Brazil. New leader Jair Bolsonaro is expected to reap the benefits of investment by state-controlled Petrobras that could see production rise 9pc in 2019, from 2mn bl/d to 2.4mn bl/d, according to financial services provider UBS.

Opec, not for the first time, is faced with the Catch 22 dilemma of having to cut supplies to support the price, but by doing so concede market share to the US. "It's quite a balancing act to pull off," says Adrian del Maestro, oil and gas strategy director at consultancy PwC Strategy&.

Ariel Cohen, a senior fellow at the Atlantic Council, and founding principal of International Marketing Analysis, says as long as US production grows annually at a faster pace than global demand, "which it has several times in recent years, Opec is going to have to live with either production cuts—which also help to bolster marginal US producers—or lower prices. It is certainly a dilemma for them."

Of course, price direction also depends on macro-economic factors that affect demand, the China/US trade spat being the main case in point. A resolution of that dispute would rally prices—at least in the short term.

Some optimism

Still, by no means everyone is downbeat about the outlook for 2019. Warren Patterson, a commodities strategist at ING, another financial services firm, has pencilled in an average Brent price this year at $69/bl. He says Opec+ has done enough by agreeing to cut output by 1.2mn bl/d at its meeting in December. Combined with Alberta's decision to trim 325,000 bl/d to alleviate a supply build-up, "we reckon the market will be in balance in the first half and we could see a small market deficit in the second half". With WTI below $50/bl, Patterson believes there's "very little incentive" for US producers to ramp up production.

"The EIA is presuming 1.2mn bl/d production growth, but we could fall below 1mn from the US over the year as a whole," he adds.

Oswald Clint, at researcher Sanford Bernstein, is forecasting an average $70/bl for this year. He says inventory levels will not be significantly above normal in 2019. Also, in many non-Opec countries—Mexico and Gabon for instance—"production is naturally declining, cuts or no cuts". Shale will not grow forever, he adds: "If Opec takes the long view and asks whether shale can keep growing for 10 years, our answer would be no—maybe for five years, then it plateaus."

Del Maestro says the Permian break-even price will become challenging if the price drops below $50/bl (Brent). "At that point swing producers will start to think more carefully," he adds.

Opec's improved data

Opec is still a power to be reckoned with, says Clint, even though its influence has declined. Aspirant, developing countries view the organisation as an exclusive club well worth the membership fees. The Republic of Congo last year became the 15th member after being accepted in June. The central African state is working on new projects that are expected to boost output by a quarter to 350,000 bl/d in 2019.

Cohen says Opec has "significantly" improved the quality and quantity of data available on the international oil market. "This is vital for an industry whose smooth functioning requires months and years of careful planning. Members get access to important macro-economic data, and there are networking opportunities that can help lure investors," he says.

"There are ominous signs that a supply tsunami is building"—McNally, Rapidan

The Opec club—like most others—is highly political, and Congo's entry shows how the game can work. Its application was backed by the United Arab Emirates and Saudi Arabia—but only after President Denis Sassou Nguesso downgraded his country's alliance with Qatar. Doha is involved in a row with Saudi Arabia and other Gulf states for, among other things, allegedly supporting terrorism.

Qatar, for its part, this month quit the organisation as a snub to its former Gulf allies. Iran, however, remains in, despite the dominant role of arch-adversary Saudi Arabia. Doubtless, it likes to remain a thorn in the kingdom's side, and often leads arguments against quotas.

Opec has more than doubled in size since its creation in 1960, but it has long been susceptible to a revolving-door system when it comes to membership. For countries that export petroleum at relatively low volume, their limited negotiating power as Opec members does not justify the burdens imposed by production quotas.

Revolving door

Ecuador withdrew from Opec in December 1992 because it wanted to produce more oil than was allowed under an Opec agreement. It rejoined in 2007. In 2008, Indonesia left the organisation, having become a net importer of oil. It rejoined in January 2016, but announced another "temporary suspension" of its membership at year-end when Opec requested a 5pc production cut.

Del Maestro says: "It's now clear there is more influence in Opec's hands than some have been claiming. A couple of years ago people were writing off the group as irrelevant. But, together with Russia, it has recovered some of its clout, but whether that clout has longevity, only time will tell."

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