OPEC, OPEC and more OPEC will be what oil markets will be all about next week

Markets are looking ahead to a crucial meeting of the OPEC+ alliance to determine as to whether the price of oil can continue in its northerly trajectory depending gon the outcome of the gathering and as to whether there will be an extension to production cuts in 2020. 

• CME OPEC Watch Tool: Probability of OPEC+ maintaining output cuts stands at 81.51%

Bloomberg has reported that "for the last year, Saudi Arabia has largely turned a blind eye to cheaters within the OPEC+ alliance, cutting its own output more than agreed to offset over-production from the likes of Iraq and even Russia. Now, Riyadh’s had enough."

Opening paragraphs

Prince Abdulaziz bin Salman, who took over from Khalid Al-Falih in September, will likely use his first OPEC meeting as Saudi oil minister next week to signal OPEC’s dominant producer is no longer willing to compensate for other members’ non-compliance, according to people familiar with the kingdom’s thinking. OPEC meets in Vienna on Dec. 5, followed by the larger OPEC+ alliance, which includes Russia, the next day.

“Saudi Arabia is taking a harder line than in the past,” said Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. in London. “Riyadh is making very clear that they don’t want to shoulder all the cuts alone.”

The willingness to tolerate cheating was a key part of the “whatever it takes” policy that Al-Falih set out in late 2016, borrowing a line from central banker Mario Draghi.

Al-Falih paid lip service to dealing with the cheating, trying to cajole OPEC+ nations to cut output as much as they had promised. But when his admonitions failed and oil prices faltered earlier this year, endangering the initial public offering of state oil producer Saudi Aramco, he simply decided to bear the burden. Earlier this year, in an abrupt change to decades of Saudi oil policy, Riyadh cut production far below their agreed target.

Key notes

• Saudi officials privately say Prince Abdulaziz will simply reiterate the decades-long Saudi mantra that everyone needs to contribute to make the production cuts successful.
• “Every country counts regardless of its size,” he said at the opening session of the meeting.
• The cheating has been widespread. Iraq, for example, should be pumping no more than 4.51 million barrels a day; but in some months it produced nearly 4.8 million barrels a day. Kazakhstan accepted a limit of 1.86 million barrels a day, however, it has produced closer to 1.95 million barrels. Nigeria agreed a quota of 1.68 million barrels a day, but has regularly pumped more than 1.8 million barrels a day.
• Russia has pumped more oil than allowed by the OPEC+ deal in eight months this year. It has complied with the agreement in only three months of this year -- May, June and July -- when disruption to the key Druzhba oil pipeline pushed production below its OPEC+ target.
• The policy of accommodating cheating has been costly for the kingdom. Riyadh was forced to reduce its own production as much as 700,000 barrels a day below its own OPEC+ quota to prevent oil prices from falling.
• As Saudi Arabia had to cut production deeper than others, it’s reaped fewer rewards from the recovery in oil prices. Russia, for example, is earning about $170 million a day more than it did in the final quarter of 2016 when the OPEC+ cuts were first agreed, according to the International Energy Agency. Saudi Arabia is earning just $125 million more.
• For OPEC watchers, the test of how far Saudi Arabia is ready to get tough with cheaters is whether the kingdom brings production back to its official OPEC+ quota of 10.31 million barrels a day and sustains it for several months.

Oil market implications

The price of oil has been elevated in a correction from the early October lows down below the $51 handle. The price of oil is highly sensitive to production cuts, as per the rally seen at the start of this year while WTI climbed from the depths of the 2018 lows in the $42 handle to a YTD high on the $66 handle. Considering the trade wars and negative ramifications for the global economy, it is essential for bulls that OPEC extends production cuts in 2020. 

However, in recent trade, crude oil prices dipped as hopes of deeper cuts from OPEC faded. "A key advisory committee to OPEC’s Economic Commission Board suggested that the oil market will be balanced in 2020 if the OPEC+ group maintains current production cuts," analysts at ANZ Bank explained.

"This comes ahead of the OPEC+ meeting in Vienna on 5–6 December. We see the market pushing into a small surplus in H1 2020 and tightening in H2 on the back of stronger demand. As a result, we don’t expect the OPEC+ group to deepen cuts."

• CME OPEC Watch Tool: Probability of OPEC+ maintaining output cuts stands at 81.51%