OPEC: Life after Deal

OPEC appears to be nervous that its production cut deal will once again fall short, and the group is already discussing the possibility of yet another extension. Part of the reason for the group’s struggles is that the two exempted members – Libya and Nigeria – have added large volumes of new supply this year. But Oil Price reports in its article What Happens If The OPEC Deal Expires? that even capping Nigeria’s output at its current rate would not solve OPEC’s problems. That is why the group is reportedly considering another three-month extension, pushing the deal through mid-2018.

While the aftermath of Hurricane Harvey continues to drive headlines in the energy sector, the attention will once again shift back to OPEC as the year wears on and we head into 2018. OPEC had hoped that a nine-month extension of its original six-month production cut deal – 1.2 million barrels per day from OPEC, plus reductions of nearly 0.6 mb/d from non-OPEC countries – would be enough to “rebalance” the market. But with seven months or so left to go on the deal, they are already coming around to the conclusion that it won’t be enough.

Nigeria’s output is up to about 2.2-2.3 mb/d, according to government officials, a figure that includes condensate. Based on that figure, S&P Global Platts says Nigeria’s crude output probably stands at about 1.8 mb/d, which comports with OPEC’s latest estimate. In other words, Nigeria is now producing about 400,000 bpd more than it was a year ago on the eve of the original OPEC agreement.

Libya too has ramped up output dramatically, topping 1 mb/d recently, essentially twice as much as a year ago, although Libya’s output has seesawed lately on pipeline and oilfield outages.

Although exact figures are a bit elusive, those two countries have added between 700,000 and 900,000 bpd of new supply in the past year, going a long way to offsetting the production cuts from the rest of the OPEC. In other words, one of the principle reasons that OPEC’s efforts to balance the market are floundering is because of the resurgence of supply from its exempted members, Libya and Nigeria. It is no wonder why OPEC officials are trying to bring Nigeria, at least, formally into the agreement by taking away its exempted status.

In the past, Nigeria’s oil minister Emmanuel Kachikwu said that Nigeria would join the agreement when its oil production returned to 1.8 mb/d, a threshold it appears to have reached.

OPEC has invited both Libya and Nigeria to its upcoming monitoring meeting on September 22. The pressure to put a limit on Nigeria’s production could rise ahead of the official meeting at the end of November.

The proposal is gaining traction, and there are some signs that other members, including Iran, could sign on.

“There are concerns that if OPEC and non-OPEC producers exit the market in March, traders will react quite negatively to it and behave as if the market is in a free fall,” a senior Saudi oil official told the Wall Street Journal. “This also ensures that producers won’t pump full tilt and push prices down.”

An extension would surely be welcomed by oil traders looking for some reassurance that prices won’t crash again. Plus, compliance has actually ticked up a bit recently, with Iraq, in particular, boosting its efforts.

But letting the deal lapse in June 2018 as opposed to March is not really a game-changer. A much bigger question is what happens when the deal expires, regardless of the precise end date. What is the exit strategy? Will the group immediately go back to producing at maximum capacity? Not only are there not answers to those questions, but there is little evidence that top OPEC officials have any semblance of a strategy beyond keeping the current cuts in place for the time being. An extra three months might not do a lot to move the market closer to some sort of balance.

And based on OPEC’s current output, and the current supply/demand dynamics, it could arguably take years to normalize inventories. “If they wish to achieve the reduction of oil stocks down to the five-year average, they’re going to have to dig in for the long haul,” Neil Atkinson, head of the IEA’s oil markets and industry division, told Bloomberg in an interview last month. “Rebalancing is a stubborn process.”