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Bloomberg View: OPEC, the future is probably worse than you thought . . . . The latest figures from the Department of Energy made grim reading for the producer group.

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by Julian Lee

June 9, 2019

(Bloomberg)  Saudi Arabia and Russia are on a collision course.

On Friday the International Energy Agency will publish its first forecast of oil market balances in 2020. The headline figures will probably show stockpiles rising next year if the OPEC+ producer group doesn’t extend output cuts into a fourth year..

But their pain may not end there. Growing signs that demand growth is turning out to be much weaker than expected may require producers to make even deeper cuts. If so, that could spell the end of the partnership between Saudi Arabia and Russia on oil policy.

The production restraint agreed in November and December 2016 by OPEC and a group of supporting countries – Russia was the only one that offered a substantial voluntary reduction – was meant to drain excessive inventories and bring global supply and demand into balance during the first six months of 2017.

By mid-2019 that still hasn’t happened, despite a prolonged period of relatively robust demand growth that has seen the world’s oil consumption increase at an average rate of 1.4% per year over the period from 2017 through 2019, according to the most recent IEA figures. That’s equivalent to around 1.33 million barrels a day of additional demand each year.

Slowing Growth
But the IEA has made a big cut to its assessment of oil demand in the first quarter. While the annual average figure hasn’t come down much, the move is worrying because it covers the only period for which we have any real data on consumption. The assessment may be cut further as more numbers come in and reductions to forecasts will almost certainly follow for subsequent periods.

Cutting Down
A Morgan Stanley report published last week argued that “there is growing evidence of a sharper-than-expected slowdown” in oil demand growth. Year-on-year increases are “grinding to a halt” across March and April for eight early-reporting countries, including China,India and the U.S. That is worrying because the IEA expects those three countries alone to account for 70% of the world's oil demand growth this year.

So where does that leave the producers? Whenever they next meet, it is almost certain they will decide to extend the current policy of restraint until the end of the year.

Sure, there may be some tweaks to the actual target levels for some countries – Kazakhstan wants to be able to produce more, as output rises from its giant Kashagan field. Russian oil companies also want restrictions eased, but any decision will ultimately rest with President Vladimir Putin, not the country’s energy industry.

But just extending the current deal may not be enough. The OPEC+ group has adopted stockpiles as its measure of success, with the focus shifting from the relatively opaque global figure to the highly visible U.S. inventory numbers, published each week.

An Exceptional Week
The latest figures from the Department of Energy made grim reading for the producer group. Total inventories of crude and refined products soared by 22.44 million barrels in the last week of May — the biggest week-on-week increase in data going back almost 30 years.

Although both the Saudi Arabian and Russian oil ministers talked up the benefits of the OPEC+ deal at the St Petersburg forum, Russia’s President Vladimir Putin had earlier asserted that the two countries “have certain differences in opinion regarding the fair price” for crude. The Russian leader says $60-65 a barrel – which is around the current level – “suits us just fine.”

While the OPEC+ ministers may be able to get away with extending their deal for another six months, a crunch is going to come when Russia decides it has had enough of restraint. For now, export restrictions resulting from the lingering contamination problems with its export pipeline to Europe are helping keep the nation’s output below its target, but once that is resolved, the industry will once again press to boost production.

Even Putin may balk at asking Russian oil companies to make deeper cuts to support prices. If he does, the OPEC+ co-operation will start to unravel.

Edited by Falcon

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