OPEC plus Has Capacity to Offset Iran Crude Supply Cuts

Oil & Gas
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Wednesday, May 29, 2019   /07:30AM / Fitch Ratings


OPEC+ is likely to mitigate the decline in Iran's production due to US waivers ending, Fitch Ratings says. This will not necessarily mean an increase in the alliance's overall production and could be effectively achieved through ramping up output within existing quotas or redistribution of quotas. The alliance has adjusted its output to offset fluctuating global supply and demand since its formation in 2016. Crude price volatility is increasing in the short term, however. 

The pressure on buyers of Iranian oil has intensified and the country is likely to reduce exports. This is due to the US not renewing waivers to continue to purchase crude from Tehran for China, India, Italy, Greece, Japan, South Korea, Taiwan and Turkey. This is likely to reduce spare capacity elsewhere in the market and has already caused price volatility. It also increases the chances of oil prices rising in the short term. 

We believe it is unlikely that Iran's exports will fall to zero as some countries, notably China, continue to buy oil from it despite the removal of waivers. However, we assume export volumes could halve, compared to around 1 million barrels per day (MMbpd) at the beginning of the year, as Italy, Greece and Turkey have stopped buying Iranian crude. 

OPEC+ countries, especially Saudi Arabia, which cut production more than it has committed to, are likely to need to increase production in 2H19 to meet global demand, but any changes in output are likely to be incremental. This is to avoid a similar situation to the one last year, when Saudi Arabia, Russia and other countries increased production after the sanctions on Iran were announced, but the US unexpectedly issued waivers, which resulted in overproduction and Brent falling to USD50/barrel by the end of the year. 

At end-April OPEC+ had around 2.0-2.5MMbpd of unused capacity, mainly in Saudi Arabia. This spare capacity could be used to quickly replace Iran's reduced volumes while maintaining overall OPEC+ production broadly unchanged. OPEC+ reported overcompliance (exceeding agreed production cuts) of 168% in April 2019 and it potentially has the ability to raise output by around 0.6MMbpd and remain formally in line with the guidelines agreed in December 2018. 

The reduced spare capacity could lead to higher volatility in the market over the next few months. But the level of prices will also depend on many other factors, including production dynamics in US and in countries with high operational risks (e.g. Nigeria and Venezuela), and global demand. We expect Brent to average USD65/bbl in 2019, in line with the year-to-date prices.


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However, in the longer term spare capacity would be likely to normalise even if sanctions on Iran remained in place. Many OPEC countries, including UAE and Kuwait, have plans to increase their oil production capacity despite the OPEC+ commitment to regulate their current output. For example, Abu Dhabi's ADNOC (AA/Stable) plans to increase its capacity from 3.5MMbpd at end-2018 to 4.0MMbpd by 2020 and 5.0MMbpd by 2030. This supports our assumption that in the long term prices will come back to USD50-60/barrel. 

OPEC+ is a petro alliance of 24 countries, including 14 OPEC members and 10 non-OPEC members, the latter including Russia, Kazakhstan and Mexico, which produces over half of global oil output. The alliance was formed in 2016 with an initial agreement to cut combined production by 1.8MMbpd to counter lower demand and growing US shale crude production to support oil prices. The alliance has been adjusting its targets since inception in response to crude supply-demand fluctuations. 

The alliance's agreements are ultimately supportive for the credit profiles of the oil companies located in OPEC+ countries, including ADNOC, Saudi Aramco (A+/Stable) and Russia's Rosneft. Although the companies' volumes have been negatively affected, the agreements helped bring the market closer to equilibrium and stabilise oil prices.

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