News ID: 251509
Published: 0219 GMT April 16, 2019

OPEC gambles with success of production cuts as $80 oil looms

OPEC gambles with success of production cuts as $80 oil looms

By Grant Smith

After managing to revive oil prices through production cutbacks, OPEC now risks squandering its victory again by letting crude oil surge too high.

In the first quarter of 2019, coordinated production curbs by OPEC and its allies helped oil rally the most in almost a decade, restoring prices to over $70 per barrel.

Saudi Arabia, the group’s member, has made clear that it’s determined to keep supplies tight. That risks a repeat of 2018, when production cuts propelled oil to a four-year high, provoking a backlash from US President Donald Trump and a hasty reversal by the kingdom.

“It appears that the producer group is overtightening the market,” said Ed Morse, head of commodities research at Citigroup in New York.

OPEC and its partners launched a new round of output cuts at the beginning of the year when it looked like booming US shale-oil production and fragile global demand growth would lead to a supply surplus. But as the group implements the curbs, and as supplies are squeezed further by crises in Venezuela, there’s now a greater risk of a shortage.

 

Supply contraction

If the group continues with its cutbacks, global oil inventories will contract by almost one million barrels per day in the third quarter, the steepest drop in nearly two years, data from the organization shows. However, the group won’t make a decision whether to extend until it meets in late June.

The strain on markets could go even deeper. A conflict is flaring in Libya, output is plunging in Venezuela because of a spiraling economic crisis, and the US will soon decide whether to tighten sanctions on Iran’s oil exports.

“There’s no doubt that in a scenario where Brent crude heads to $80, President Trump will voice his concern,” said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA.

Pursuing higher prices also risks straining the Saudis’ critical alliance with Russia, which is cooperating with OPEC in the pact to curtail supply.

Russian President Vladimir Putin said last week that he’s comfortable with current price levels, and that it’s too soon to decide whether output needs to be restrained in the second half.

To avoid a repeat of last year, Saudi Arabia could increase production slightly, stopping a surge in prices. The kingdom is cutting output by considerably more than required under the OPEC accord, and so it could raise supplies without breaching the pact.

 

Search for balance

On April 8, less than two weeks after President Trump urged OPEC to increase production, Saudi Energy Minister Khalid Al-Falih said that his priority of “bringing back inventories to a reasonable level remains unchanged.”

Saudi Arabia faces powerful domestic pressures to press on with the policy, from Crown Prince Mohammad bin Salman’s plans for radical economic transformation to a government budget that hinges on oil prices of $80 per barrel.

A year ago, Riyadh’s decision to let prices approach that level backfired.

In April 2018, when oil was trading at about $70, the Saudis signaled at an OPEC gathering in Jeddah they were comfortable allowing crude to climb even higher.

Their stance provoked a furious response from US President Trump, and though Riyadh initially brushed off his concerns, within two months they bowed to his wishes and raised production.

The kingdom subsequently bolstered output to record levels, flooding the market and sending prices crashing below $50 per barrel. The move was strongly influenced by US promises to decrease Iranian shipments using sanctions, a pledge the Trump administration reneged on at the last minute.

This time, the Saudis are probably holding off on any action while they await a US decision early next month on how to proceed with sanctions on Iran’s exports, Tchilinguirian said.

Regardless of Trump’s decision on Iran, with inventories set to shrink and supply losses looming elsewhere, the Saudis could face the same boom-and-bust outcome seen last year.

“OPEC has been very good lately at getting the market moving in the direction it wants, but less good at steering the market once it nears the destination,” said Brower. “It’s never really understood when to call time on a rally for its own good."

 

The above article originally appeared on Bloomberg.com.

 

   
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