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OPEC - Between A Rock and A Hard Place

Proshare

Thursday, June 01, 2017 09:10 AM/FDC

Background
Six months ago, a marriage of convenience was brokered between the Organization of the Petroleum Exporting Countries (OPEC) – led by the Saudis – and a group of 11 Non-OPEC oil producers led by the Russians.


The 24-country coalition united to achieve a sustained oil price recovery. It delivered oil production cuts that exceeded all expectations- approximately 1.8mbpd and price increase of 5.6% to the YTD peak of $57pb. OPEC said it would “do whatever it took” and had seemingly done so.


Markets reacted positively on news of the landmark deal. So did US shale produc-tion. It surged in response to higher oil prices.


Markets Hardly Enthused

Fast forward six months later: OPEC and its allies extend existing cuts for another nine months to March 2018. Even with this strat-egy, inventory levels remain well above the OPEC target range. The market surplus built up over the past three years will take a lot longer to clear than anticipated.


The market remains unimpressed with this outcome. Consensus among analysts and traders is that only deeper cuts to production will prop up prices at this point. The lack of a long-term plan is what the market finds most disappointing.


Without any specific strategy on what happens beyond March 2018, fears are rife that OPEC will return to the internal scuffling and infighting that trig-gered the slump in prices to below $30pb between 2014 and 2016. Brent crude fell 5% to $51.24pb on the news while futures fell to as low as $48.45pb before settling at $48.90pb.


Another key factor is the global demand for oil is lower than expected so far in 2017. Advancements in technology and a gradual shift to renewable forms of energy means a steady push away from oil and gas in the medium to long-term. It may be that the appetite of industrialized nations for oil has peaked.


Nigeria Exempt Again: Timely and Opportune

Nigeria and Libya retain exemption status while Iran – which ramped up output under the initial agreement – has an unchanged output target. This exemption comes at an auspicious time for Nigeria as it passed the first part of its Petroleum Industry Governance Bill – 16 years after it was first considered.


It raises hopes that the other parts of the bill, covering the rights of the host communities and a package for fiscal incentives, will be passed quickly enough.


Nigeria is more sensitive to changes in oil production than to changes in oil prices – even more so now in an era of lower oil prices. The government’s fiscal plans hinge on ramping up production.


It pegged its oil benchmark production at 2.2 million barrels per day (mbpd) - a milestone it failed to reach since mid-2011. Oil pro-duction averaged just over 1.4mbpd in the past year. Disruptions to oil output, as a result of militancy in the host communities, were re-sponsible for much of this.


As a result, the Nigerian oil industry failed to attract the necessary capital investment to fund exploration and development to achieve its oil production targets estimated at $7bn annually according to the Nigerian Investment Promotion Com-mission (NIPC).


With the right fiscal incentives and an end to militancy in the Niger-Delta region, Nigeria can surpass its own production target and even ramp up production to service growing demand for domestic oil re-fining.


Unrelenting Shale

The one clear winner is US shale. Production cuts created a space in the market for it to fill and if higher prices are achieved, then shale producers become more profitable. This is a problem that is not about to go away.


Shale oil continues to be cheap and abundant and its producers are back in full swing, riding on a new wave of optimism. Fracking – the process by which shale oil is extracted – is increasingly seen as more reliable than conventional drilling operations. It is less vulnerable to shifts in production and price, and has attracted a lot of investment.


What next for OPEC?

The lack of a clear plan of action after March 2018 begs the question, what is the exit strategy? AL-Fihah – the Saudi oil minister – said he expects OPEC to achieve its goal of returning global oil inventories to the five-year average by the end of 2017.


If that does not materialize, another extension cut may be in the cards as the Saudi minister has been quoted as saying “We will develop it based on the conditions that present themselves at that time”. On the other hand, if targets are achieved, a new strategy may not be needed.


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