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Opec+ stress test as oil price lifts off

Cartel heavyweight Saudi Arabia draws heat from White House and Russia

What next for the oil price? An increase of about 40pc since January to c$74/bl has been spurred by the Opec+ supply cuts, as well as US sanctions against Iran and crisis-hit Venezuela, where production losses have been deeper than forecast.

On trading floors, the mood is one of uncertainty — not least about the impact on future supply following President Trump's recent decision to scrap waivers granted to some countries, including China, following the imposition of Iranian sanctions from January. The immediate response was another leg-up in the oil price. Now, the question is whether traditional swing producer Saudi Arabia will step in and plug the gap left by the potential loss of even more Iranian crude.

Other questions loom large. Will there be significant supply disruption in Libya, where civil war has entered a new and dangerous phase? What will be the extent of a possible loss of Algerian exports in the wake of internal unrest, and likewise South Sudan, given the political turmoil in its transit country neighbour Sudan?

Maintain direction?

Against the backdrop of a rising oil price and supply-disruption, Opec+, underpinned by its biggest producers Saudi Arabia and Russia, must decide at their June meeting in Vienna whether to roll over their supply cuts agreement, which pledged to shrink production by 1.2mn bl/d. A different path would be to continue co-operation but amend the accord, with the cuts tally reduced to get more oil flowing — taking on board concerns markets could be seriously under-supplied later this year, leading to another price surge.

Financial services firm RBC Capital Markets has already revised up its Brent average forecast for 2019 to $75/bl, while others are talking of spikes that could take the price to over $80/bl — a level around Saudi Arabia's fiscal break-even point.

Iran waivers, the implosion of Venezuela and signs of a thawing of relations between Washington and Beijing have all contributed to the run-up in the price. But, given sanctions targeting Caracas were imposed after Opec+ had set the date of their recently cancelled summit in April, and with continuing uncertainty over future Iran waivers, perhaps it was no surprise the cartel pulled that meeting, preferring to wait for more clarity prior to their next gathering on 25-26 June.

0.5mn bl/d —production cuts in March

Key data has already emerged that should help with decision-making. OECD commercial inventories declined from 2,893mn bl in January to 2,871mn bl in February. Oil supplies from Opec sank by half a million barrels a day in March, hitting a four-year low, as Saudi Arabia continued to slash output and Venezuelan production plunged. The monthly production decline amounts to roughly 0.5pc of global oil demand.

But Saudi Arabia, Opec's lynchpin, is more eager than ever not to make the same mistake it did last year when the kingdom opened its taps too early on fears of a supply crunch with the result that the oil price slumped from a high of $86/bl in October 2018 to just below $50/bl by year-end. The decline was magnified by worries about the state of the world economy as China and the US traded blows in a still unresolved trade war.

John Kemp, senior market analyst, commodities and energy at information firm Thomson Reuters says that if the White House toughens sanctions on Iran and Venezuela, the decision would likely be tied to production increases by Saudi Arabia.

"The White House is likely to agree to scale back Iran sanctions waivers if, and only if, Saudi Arabia commits to replacing the lost barrels at least one-for-one to leave the global production-consumption balance unchanged," says Kemp.

Otherwise, expect those hostile tweets from President Trump to roll thick and fast.

Jason Gammel, senior oil analyst at investment bank Jefferies expects the US will eliminate waivers only for those countries not using them — Taiwan, Greece and Italy. "I would expect extensions would be focused on China, India, Turkey and South Korea, with some level of reduction in their allowances," he says.

Supply cuts and declines from Venezuela and Iran have already pushed the market into deficit, according to Opec. In March, Opec production plummeted by 534,000bl/d to just above 30mn bl/d, a four-year low. Opec has had to sacrifice market share, though, to boost prices. The organisation has estimated that demand for its crude will have fallen by 2.6m bl/d between 2017 and 2019.

Russian breach

Gammel says the data showed compliance was uneven, with Saudi Arabia cutting production to 9.8mn bl/d, from 10.1mn bl/d in February, making it 250pc compliant. Under the agreement Saudi Arabia was obliged to cut only to 10.3mn bl/d from 10.6mn bl/d. Russia, on the other hand, was only 52pc compliant.

One possible move for Opec+, given fears of a tightening market, would be for Saudi Arabia to ease its grip on the taps by opting merely for full compliance. After all, Saudi Arabia hardly wants to do all the heavy lifting on its own — that was a key reason it pushed for an alliance with Russia and others in 2016.

"My own interpretation is that the Russians have tried to maintain the political alliance but have not done much to reduce their own output so far this year. They are not complying with their targets," says Gammell.

"Russia sees its oil tie-up with Saudi as a counterweight to US shale and underlines its strategic objective of expanding its influence in the Middle East. For the Saudis, at a strategic level, it means they don't have to have all their eggs in the American basket," says Kemp.

"I would expect extensions would be focused on China, India, Turkey and South Korea, with some level of reduction in their allowances" — Gammel, Jefferies

Russian president Vladimir Putin faces pressure from within Russia to boost domestic production to take advantage of higher prices and stick it to American shale producers who are hoovering up market share. But Richard Mallinson, co-founder of London consultancy Energy Aspects said the Saudis have made it clear inventories are not yet at a level that would justify "a declaration of mission accomplished".

"They are signalling that the deal is very likely to be rolled over, but it may not be rolled over at the same volume or for the same duration," says Mallinson.

In the interim, the US has become the world's biggest producer at 12m bl/d and the higher the price the more the incentive for US production.

Oswald Clint, senior oil and gas analyst at investment bank Sanford Bernstein says that his take on the market was that it was "balanced to tightening". "If you look beyond shale, it is not as if Russia has significant growth potential. They need to get back drilling to offset 2pc to 3pc annual output decline rates. They have investors who want growth and higher dividends, and the only way to do that is through volume growth," says Clint.

His view is that US shale production growth is also slowing, forecasting that growth would fall from 2.2mn bl/d in 2018 to 1.6mn bl/d.

Contango in the oil price curve was signalling a market expectation of a tighter supply-demand balance in the second half of the year, says Kemp, with a significant drawdown on global oil inventories expected later this year.

"We can already see hedge funds and traders taking long positions. They have been net buyers of petroleum futures for the last 13 weeks or so," says Kemp.

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