COMMENTARY. Compliance by producers is key to OPEC’s rebalancing act; all eyes on Nov 30 meeting

At $64 a barrel, crude oil prices have surged to their highest level in two years. Driven by a combination of geopolitical tension, decrease in output in some origins, talk of additional and extended production cuts, and strengthening demand outlook, crude prices rose by 10 per cent in October and by 20 per cent in the last two months. Compared with this time last year (around $48), the market is up over 30 per cent.

The stand-off between traditional rivals Saudi Arabia and Iran as also the recent events in Saudi Arabia have, in some way, unsettled the oil market. Indeed, speculative capital has quickly moved into crude futures, exacerbating the price impact.

Clearly, the process of rebalancing that started in the second half of 2016 appears to be gathering pace. However, there are risks ahead for the rebalancing process to continue.

While OPEC and its partners, under Saudi Arabia’s lead, decided to cut oil production in January this year with the objective of stabilising the oil market and bringing stocks down to their five-year average, a market-share war meant that producers like Nigeria and Libya actually went ahead to produce more.

More recently, while some key participants in the ‘output-cut’ programme — such as Saudi Arabia — have slashed production in accordance with what they promised, many others in the group are still pumping above their quotas. Importantly, the recent jump in prices continues to encourage US shale oil production.

In other words, even if the output-cut programme is extended by another nine months till the end of 2018, inventories are unlikely to fall to the five-year average any time soon.

Indeed, the recent price increase has provided a shot in the arm for the US shale oil producers to boost extraction. Inventories in the US have spiked and belief is now gaining ground that there will be some liquidation of stocks.

This is sure to put downward pressure on oil prices and, importantly, shale oil is likely to eat into the market share of OPEC. This can potentially delay the rebalancing of the oil market.

In other words, OPEC will have to work on additional output cuts and ensure production discipline among its members — a tough prospect. This suggests oil prices at the current levels may not be sustainable for long as fundamentals will eventually catch up. Also, we have seen in the past that geopolitics-driven commodity price spikes are usually shortlived. Gold is, of course, a classic example; crude is no different.

The global oil demand scenario looks robust. World economic growth is slated to move to a higher trajectory in 2018, and the consumption appetite of countries such as China and India will continue to be ravenous which, in turn, will lead to a gradual draw-down of stocks.

Meanwhile, OPEC’s next biannual meeting, scheduled for November 30, is keenly awaited. There is a general expectation that the output-cut agreement will be extended till the end of 2018. But the key to success in rebalancing the market is that producers have to abide by their commitment to reduce production and follow a disciplined approach.

The author is a commodities market specialist. Views are personal.

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