This week, as ministers from the OPEC nations meet in Vienna, they must make a decision in the face of challenging and uncertain circumstances, Wood Mackenzie reports.
The producers’ group must contend with differing production expectations for Iran and Venezuela, and consider external pressure for action from the US. For Iran, the exact impact of the newly restored US secondary sanctions remains unknown. Venezuela’s production outlook remains uncertain, and recent outages in Libya may also weigh on decision-makers’ minds.
Meanwhile, US President Donald Trump is keen to see production raised by at least 1 million barrels per day (b/d) to help address perceived crude losses in the market – in effect lowering oil prices to avoid high prices damaging economic growth.
How does the group prepare for this rapidly evolving situation?
Saudi Arabia would like to see OPEC act as a unified body and continue its partnership with Russia in managing the oil market. The Russian government indicated it would like to see production increase. This must be taken into account even though three OPEC members – Iran, Iraq and Venezuela – have signalled they are against an increase in output for H2 2018. These dynamics are teeing up an intense June 22-23 session to agree on the need for more output in the market.
Focusing on market fundamentals, we look at the impact of three possible options for OPEC and co-operating non-OPEC producers.
Option 1: on the basis of our fundamentals forecast, which sees a 380,000 b/d decline in supply from Venezuela, January to December 2018, and Iran's output slipping to 3.4 million b/d by the end of this year, OPEC could maintain its goal of stable oil prices and continue the current production cut agreement. In our base case outlook, the losses from Venezuela and Iran are somewhat offset by continued growth in the US. This view leads to a small implied stock draw in Q3 2018, followed by an inventory build in Q4 2018 which is expected to weaken prices heading into 2019 when we see an oversupply for the year.
Option 2: if consensus at the meetings is for a larger decline in Venezuela or Iran, or both, compared with our base case, then OPEC and Russia along with other non-OPEC partners could decide on a production increase in H2 2018. Our analysis shows a moderate production increase in OPEC and non-OPEC could be absorbed by the market, with prices averaging $71 per barrel Brent in 2018 versus our base case of $74/b. This analysis assumes OPEC agrees to increase its output by 0.5 millon b/d, and Russia by 0.1 million b/d in H2 2018.
Option 3: OPEC could increase output by a more dramatic 1 million b/d, adding a further 0.3 million b/d from Russia to bring the total gain closer to 1.5 million b/d. Saudi Arabia could do this with Russia to weaken oil prices significantly – leading to a reduction in gasoline prices in the US, and providing support to President Trump. Such a decision, if implemented, would have a large impact on the supply-and-demand fundamentals by creating implied stock builds averaging 0.9 million b/d in H2 2018, and 1.8 million b/d in 2019.
Balancing these different factors, if OPEC and Russia were to agree on a production increase, we think it would likely be a moderate one, which would avoid a sharp downward price adjustment, yet provide a response to US pressure for more supply. This is akin to Option 2, which is more likely to gain wider OPEC ministerial support than the larger increase mooted in Option 3.
That said, much depends on OPEC and non-OPEC expectations. The outcome of the meeting remains highly uncertain.