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OPEC+ Shenanigans Weakens Its Oil Market Strategy, Confuses Supply Guidance

By Ellen Wald, PhDCommoditiesJun 04, 2020 19:40
OPEC+ Shenanigans Weakens Its Oil Market Strategy, Confuses Supply Guidance
By Ellen Wald, PhD   |  Jun 04, 2020 19:40
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OPEC+’s latest shenanigans expose the severe identity crisis facing the group, and this has consequences for the market. For several days, OPEC+ flirted with moving up the date of its June meeting, confusing many market watchers.

As of Thursday morning, the meeting is scheduled for June 10 with an OPEC Conference meeting the day before. OPEC+ is also apparently debating internally whether it will likely extend current production cuts by one month or two months.

Below is a deeper look at how the latest OPEC+ actions are impacting oil markets and a breakdown of key information we currently know about shifts in the organization and production challenges:

Failure To Provide Advance Signaling

OPEC (and now OPEC+) functions best when it sets production quotas in advance for a predetermined length of time—normally between six and 12 months in recent years. This kind of advance signaling helps the governments of OPEC countries plan their budgets. Since most of these governments depend on oil revenue, stability in the market assists budgeting. Advance signaling from OPEC also helps smooth price volatility and enables oil companies that often ship large volumes of oil over long distances to provide customers with pricing and product availability.

Right now, OPEC+ is not providing long-term advance signaling. When OPEC changes its mind regularly or sets new quotas for just a month or two—as it did in April and appears likely to do next week—it sets many unnecessary obstacles for its member country governments and the oil companies operating within their borders.

OPEC+ has been criticized in the past for failing to respond quickly to changing market conditions. This was seen most recently in February of this year, as China suffered a demand shock from the coronavirus shutdowns and OPEC+ did not call an emergency meeting. When the group finally did attempt to address the demand blow from Asia in early March, Saudi Arabia tried a heavy-handed tactic to press Russia to agree to a 1.5 million bpd cut in production. The strategy failed and resulted in a month of over-production from Saudi Arabia that startled prices. But the idea of using OPEC+ as a reactionary lever on the oil market does not work well for anyone either.

WTI Futures Weekly Chart
WTI Futures Weekly Chart

Once OPEC+ attempts to react to short-term price action—some of which has nothing to do with supply and demand and everything to do with financial speculation—it gives up any trust the market had in the group to provide medium-term or long-term supply guidance and price stability. OPEC+ is attempting to wrangle 20+ members to agree to change production rates month-by-month right now.

Trying to set rates with less than one month of advance notice is a task that is nearly impossible under optimal conditions. As traders, customers, financial institutions and commodities analysts watch this process in real-time, the group’s failure to provide the supply guidance is only more evident. The market does not and cannot know how to respond to OPEC+ rumors when it is a reactionary organization.

Oil Production: Who's Cutting, Who's Not

In all, Saudi Arabia, Kuwait and the UAE have committed to 1.2 million bpd in cuts beyond the OPEC+ requirement, but there is nothing binding them to this statement. Such an additional production cut would be significant for the market if it really happens, but the market and the other members of OPEC+ don't know if it is happening.

Russia and Saudi Arabia both see value in extending the current production cuts through July, but also want improved compliance from Iraq and other laggards. Saudi Arabia is essentially threatening to pull its commitment to cut an extra one million bpd of production in June (its portion of the 1.2 million bpd) if producers with poor compliance don’t show a firmer commitment to cutting production. These countries include Kazakhstan, Azerbaijan, Nigeria, Angola and Iraq. Within the next few weeks, it is possible that supply from OPEC+ could contract by at least another 2.5 million bpd. So far, Saudi Arabia’s production is only slightly under the 8.492 mbpd it committed to OPEC, even though it said it would cut that additional one million bpd this month. (Based on production data from Energy Intelligence).

In the United States, oil demand is picking up, but data on gasoline and diesel fuel usage indicate there are still significant weaknesses. On the supply side, U.S. production continues to decline, at least according to EIA estimates. The latest EIA weekly petroleum status report indicated that U.S. production is down to 11.2 million bpd. WTI prices have been trending higher, with the U.S. benchmark hitting $37 per barrel earlier this week. EOG Resources (NYSE:EOG), one of the largest shale oil producers, indicated that with prices over $30 per barrel, the company would start bringing some of its 125,000 bpd of shut-in oil production back online in Q3. Other shale oil producers, such as Diamondback (NASDAQ:FANG) Energy, have indicated similar, though less concrete, intentions. This doesn’t mean U.S. production is slated to grow in the near future, but it could mean that the rate of decline will slow.

OPEC+ Shenanigans Weakens Its Oil Market Strategy, Confuses Supply Guidance

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OPEC+ Shenanigans Weakens Its Oil Market Strategy, Confuses Supply Guidance

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Comments (1)
Mark Wolf
Mark Wolf Jun 04, 2020 20:00
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Even if Iraq and Nigeria commit with the cuts. Theres no way theyll be able to comply, but the pressure thats being put on the non compliant countries is warranted as its in everyones best intrest to balance prices. Especially the Saudi economy.
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