Viennese waltz: OPEC+ dancing between a rock and a hard place

Author David Fyfe, Argus Chief Economist

Early indications suggest that Opec+ may simply extend their existing output deal beyond March 2020 when they meet on 5-6 December in Vienna. Broader commodity markets have shifted higher amid signs of an imminent stage-one US-China trade deal, and the IMO 2020 bunker regulation could boost crude prices in the coming months. But widespread 2020 non-Opec supply growth, plus potentially anaemic demand, argue for deeper Opec production cuts, and could re-open old wounds around compliance.

Based on forward market fundamentals, Opec+ should be preparing further supply cuts when producers meet in Vienna on 5-6 December. The existing production accord for 2019 targeted a 1.2mn b/d reduction for Opec members and the 10 non-Opec participating producers.  Iran, Libya and Venezuela are exempt, but are struggling to maintain supply anyway. During 2019, voluntary compliance has been patchy — Saudi Arabia, UAE, Kuwait and Angola have over-performed, while Iraq and Russia have significantly under-performed. 

Opec+ may have to work harder in 2020-21

Recent weeks have seen predictions of an imminent US oil supply slowdown, alongside shortening odds of a tentative US-China trade deal — reducing risks of economic recession next year — and long-awaited market adjustments ahead of the January IMO marine fuel specification change. These modestly supportive factors led Opec secretary-general Mohammed Barkindo to predict a much easier 2020 ahead for Opec+. Some analysts now proclaim a simple extension of the deal is the most likely outcome next week in Vienna.

Of course market fundamentals for 2020, let alone 2021, remain highly uncertain —  a rapid dismantling of global trade tariffs and accelerated economic stimulus might lead to macro rebound and more robust 2020 oil demand growth; geopolitical risks remain elevated and could potentially undermine supplies from Iraq, Iran, Venezuela and elsewhere in Latin America, and even from Saudi Arabia; Russia might defy historical precedent and implement sustained supply cuts; and we could conceivably be at an inflection point for US shale output if spending collapses and productivity gains erode. 

However, at Argus we don’t believe this combination to be likely. The November issue of Argus Fundamentals points to a much more challenging year ahead than Barkindo seems to expect. Year-on-year demand growth of 1.3mn b/d in 2020 depends on a modest GDP growth recovery to 3.1pc plus some incremental IMO-related demand. And while major agency forecasts — IEA, EIA and Opec — envisage US liquids supply growth slowing from 1.6mn b/d this year to between 1.2mn b/d and 1.7mn b/d in 2020, Argus ploughs a more conservative furrow, assuming US growth slowing to nearer 1.1mn b/d next year.

Yet the problem for Opec+ in 2020 is that non-Opec supply growth diversifies from the highly US-centric mode of 2018 and 2019. Canada, Brazil, Kazakhstan, Norway and Guyana all contribute to non-Opec supply growth of nearly 2.4mn b/d next year, with a further 1.7mn b/d expected in 2021. This despite a steady tapering off in US growth, which Argus sees falling below 1mn b/d by 2021.

Non-Opec supply growth

As per the implied global oil balance, above, if Opec supply flatlines at 29.9mn b/d through 2021, this would lead to stockbuilds of 350,000 b/d in 2020 and 800,000 b/d in 2021, also pushing core Opec producers’ market share below 2010 levels. Cutting output further to eliminate global stockbuilds would push Opec market share to levels not seen on a sustained basis since the early 1990s.

Arguably, though, producers have a little time to reflect on their next move, as stockbuilds only become material from the third quarter of 2020 onwards. Indeed, there may be a triple-lock temptation to “leave well alone” in early December until IMO transition has been navigated, the results of phase-one US-China trade talks become clearer, and Saudi Arabia’s launch of Aramco’s IPO is behind it.

We've got a problem, Houston

But equally, the group will want to have in place a replacement agreement before the existing pact lapses at the end of March. Any deal for 2020, moreover, will have to corral Iraq into the fold and persuade Russia of the advantages of sustained cuts too. Neither will be an easy task. 

As ever, Saudi Arabia and its allies will be dancing the tightrope in Vienna: 
• cut too much or too early, causing a spike in crude prices that risks triggering global recession while losing market share to re-invigorated US shale output;
• cut too little, too late, potentially cratering prices, disrupting the Aramco IPO, but helping avoid recession, and undermining shale economics into the bargain.  

Indeed, while not the central scenario, don’t completely discount the possibility that Saudi Arabia takes one look at the market share implied by ongoing output restraint and is tempted to revisit the squeeze on US shale that it enacted in 2015-16. 

The issues may not be fully confronted this time around, what with all the moving parts in play between now and the end of this year. But even if producers pause for breath in Vienna next week, they cannot withdraw from their “eternal dance” for long in 2020.

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