Opec may need more than its oil output extension

Opec and its partners are all set to extend their output deal when they meet in Vienna in two weeks, but it is not certain that would be enough to ensure prices stay above $50 as the market’s gains give way to pessimism.

Khalid Al Falih, Saudi Arabia’s energy minister, said in Abu Dhabi last month that the kingdom was on board for an extension of at least three months as long as all other parties to December’s deal agShow more

Opec and its allies have run out of options ahead of their meeting at the end of this month, as oil prices slide.

It is almost certainly a foregone conclusion that oil ministers will extend their output deal when they meet in Vienna on May 25, with that outcome already baked into oil market expectations.

But the broader question is whether members will stay committed to a policy that, for its initial six-month period at least, has failed in its aim of hastening a rebalancing of a flooded world oil market.

Khalid Al Falih, Saudi Arabia’s energy minister, said last month in Abu Dhabi that the kingdom was on board for an extension of at least three months as long as all other parties to December’s deal agree, a policy that is backed by its close Arabian Gulf allies, Kuwait, Qatar, and the UAE, as well as Iraq, which together bear almost all the load of Opec’s pledged cuts.

Alexander Novak, Russia’s energy minister, which is the largest non-Opec party to the deal, threw his support behind an extension last week. “We are holding final negotiations on this topic with our partners and are inclined to think that extension is reasonable,” he said.

But the market’s gains, which had kept world benchmark North Sea Brent in the mid-to-high US$50s a barrel from December to mid-April, has given way to deep pessimism after a string of downbeat market indicators.

Now, it is not certain that an extension of the deal – which ostensibly cut 1.8 million barrels per day (bpd) from production by Opec members plus 11 non-member countries – even for another six months would be enough to ensure prices stay above $50.

“We cannot ignore the fact that the market did not care at all about increased verbal support by Opec delegates and the Russian energy minister,” said Eugene Lindell, the senior oil market analyst at JBC Energy in Vienna. “We have to ask ourselves whether our understanding of the oil balance over the coming months could be very wrong.”

Although Brent futures recovered a little on Friday, rising 72 cents to $49.10 a barrel, that followed their worst month since December, with a drop of 12.5 per cent since mid-April pushing Brent futures back to where they were just before the deal.

There are a number of complex reasons why oil prices have weakened, says Ole Hansen, the head of commodities at Saxo Bank. These include tighter credit conditions in China, which hit commodities prices across the board in the last week or so.

But primarily the market has been looking at the US, where oil output has surged back from a trough last autumn, rising by 840,000 bpd in October to 9.3 million bpd last month to cancel out at least half the pledged Opec/non-Opec cuts.

One of the most worrying aspects for Gulf Opec producers is that the glut of US oil has pushed the price of benchmark West Texas Intermediate down even further than Brent, which together with the easing of US export restrictions means the US is now competing for a piece of China’s oil market just as China’s growth rate is in doubt.

That raises fundamental questions about the effectiveness of the deal.

Thus, “conviction in the deal may be waning”, said Ed Bell, a commodities analyst at Emirates NBD bank in Dubai.

Indeed, even if Saudi Arabia and its allies were not targeting an outright price for oil – for which there are too many factors to control – they must have been expecting nearby delivery prices to rise above those for future delivery, known as a “backwardated” market, which would at least have the effect of discouraging other producers from hedging so that they would keep producing even if prices dropped, said Mr Bell.

With the latest drop in prices, the future-delivery prices are again higher than nearby-delivery prices, though at lower levels than before the deal at the end of last year.

Those market developments will have Opec policymakers wondering what else they might be able to do to make their “short jolt” strategy work.

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