Compliance relaxation on St Petersburg agenda

Saudi Arabia, Russia and the president of Opec are likely this week to discuss a controlled relaxation of over-compliance with the Opec and non-Opec production-cut target. Saudi oil minister Khalid al-Falih, his Russian counterpart Alexander Novak, and UAE energy minister Suhail al-Mazrouei, the Opec president, will meet in St Petersburg.

Such a relaxation is a "big possibility", said a Gulf source familiar with Saudi thinking. An agreement would mean Opec's kingpin, the leading non-Opec participant in cuts, and the current Opec head would have a strong proposal to take to next month's gathering of oil ministers in Vienna.

An early full unwinding of the Opec and non-Opec cuts is not currently under consideration.

The production agreement, which runs to the end of this year, aims to take around 1.7mn b/d out of production. A collapse in Venezuelan output means compliance of Opec's 14 members rose to a record high of 181pc in April, according to Argus estimates. Non-Opec discipline is less impressive but overall compliance still provides scope for participants with spare capacity to relax their output constraint and bring the overall rate closer to 100pc.

Saudi Arabia is the custodian of the bulk of Opec spare capacity and Russian companies are keen to boost output. Saudi Arabia is keen to preserve long-term co-operation with Moscow on balancing the market and so is very likely to agree that Russia benefits from a relaxation.

In assessing the current market, Opec confronts several issues. The source said "fundamentals are sound" — OECD commercial inventories are falling and are likely to hit their moving five-year average by the end of 2018 or sometime in the first quarter of next year, which would argue for keeping current production levels in place.

Opec had indicated that bringing down OECD commercial stocks to their five-year average would indicate a balanced crude market. Al-Falih and ministers from participating countries have over recent weeks said the search for alternative metrics is underway.

The Gulf source said prices are rising on expectations of a further decline in Venezuelan output and a possible decline in Iranian exports because of US sanctions, rather than on actual current supply-demand fundamentals.

The uncertainty surrounding how US sanctions will affect Iranian exports means Opec and its main Mideast Gulf producers — particularly Saudi Arabia, the UAE and Kuwait — will keep issuing reassurances that they will plug any shortages that arise.

"Nobody knows exactly what will happen to Iranian exports, how much they will be, how much we are going to miss," said the Gulf source.

"There are many dimensions to this," which include how countries and companies in Europe and Asia-Pacific will deal with the new sanctions and to what extent they will comply. Even if the sanctions have a strong effect on Iranian exports, this will not be apparent before the end of the year, said the Gulf source.

"So Opec and non-Opec want to judge the situation to get a better picture of what is really going on. But if there is a need to relax compliance, they will."

Most Opec and non-Opec countries party to the restraint agreement are producing all they can, with only a handful of producers shutting in spare capacity. Iraq's April output exceeded its agreed target. Countries with spare capacity include Saudi Arabia, the UAE, Kuwait and Russia.

The modalities of any relaxation and how this might be distributed is likely to be discussed in St Petersburg. It is also likely to be discussed at the level of Opec experts meeting to assess compliance and the market situation, then at Opec's meeting in Vienna on 22 June, ahead of a meeting with non-Opec participants in the cuts deal.

Opec producers determine the extent to which the global market is over-supplied or under-supplied by studying supply-demand balances prepared by the group, by the IEA and by other sources, as well as by talking directly to buyers of their crude, said the Gulf source. Buyers always talk about price and whether supply is plentiful or tight.

Iran has accused some Opec members that are offering to offset any falls in its output of working with the US to increase prices.

Increasing output to offset a fall in Venezuelan and Iranian output will doubtless lead to accusations of appropriating market share, complicating any future quota negotiations within Opec. But the Gulf source said production capacity is "not static", and changes in capacities over time invalidate demands by some producers for parity with others based on historical output levels.