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Abu Dhabi, UAEMonday 18 June 2018

Opec's oil price success could be its undoing

Prices rising too fast could tempt some producers to exceed their quotas

Higher oil prices will test Opec's discipline. A spell of bad winter weather in the US and recent unrest on the streets of Tehran have helped push the value of a barrel of Brent crude close to over US$70 for the first time in three years. The strong start to the year may be good for public finances in the Middle East but it could also cause some awkward problems for the producer group. Compliance with another year of output cuts may come under pressure.

Brent crude has climbed 10 per cent to above $69 a barrel since late November when Opec agreed with Russia and other major producers outside the group to extend output cuts until the end of 2018. The logic behind the deal struck in Vienna was that more work would be required to re-balance oversupplied markets and reduce global stockpiles. Now prices rising too fast could tempt some producers to exceed their quotas.

Compliance has so far confounded skeptics. According to the latest S&P Global Survey of production the 14-member bloc had a slight increase in overall output in December to 32.4 million barrels per day. However, restraint amongst the 10 members bound by quotas was strong at 135 per cent in the same month. But testing times are ahead. From next month all the group’s members including Libya and Nigeria, which had secured exemptions, will be subject to quotas.

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The pressure to capitalise on higher prices could be even greater for Opec’s major partners such as Russia. Moscow may have taken a leadership role in holding together the current deal to re-balance the market but its ongoing commitment could be tested by the country’s independent oil companies lobbying hard for an exit. The first test of the country’s commitment could come later this month when energy minister Alexander Novak co-chairs the next meeting of the joint monitoring committee in Oman alongside his Saudi counterpart Khalid Al Falih.

“Certainly the Russian corporates will likely resume their campaign for an early exit if oil hits $70, but is the higher price really so bad for Putin? I do not expect a public pullout though there may be so under the table compliance slippage,” Helima Croft, global head of commodity strategy at RBC Capital Markets told S&P Global Platts.

Higher prices are unlikely to shift Saudi Arabia’s resolve. The kingdom – the world’s largest exporter of crude – produced less than 10 million bpd in December, according to figures compiled by S&P Global Platts. Riyadh needs prices higher than $70 a barrel to balance its budget and entice international investors to buy shares in the planned initial public offering of Saudi Aramco. The listing is expected to raise around $100 billion, provided it receives a valuation close to $2 trillion.

Iran’s oil minister Bijan Zanganeh cautioned this week that Opec members were “not keen” on prices climbing above $60 for fear of stoking US shale output. Production from the US is expected to exceed 11 million bpd by the end of next year, breaking previous records as higher prices encourage more drilling in the country’s major shale basins, according to the latest short-term forecasts by the Energy Information Administration.

Mr Zanganeh comments follow a weeks of unrest in Iran with protests held in dozens of towns and cities across the country. Iran’s economy has failed to benefit from higher oil prices with inflation returning to double digit levels adding to the financial burden caused by the withdrawal of some subsidies.

Meanwhile, the embattled Islamic republic produced 3.82 million bpd in December, a slight rise from the previous month, according to the S&P Global Platts survey.

“The Iranian oil minister statement confounds and fascinates me because it was the proposed subsidy reductions that sparked the largest wave of anti-government protests since 1979. Hence other elements in the embattled leadership may ‎welcome the higher price and may be more focused on keeping the streets quiet than US shale,” said Ms Croft.

The output-cut agreement, which came into effect in 2017, called on Opec and 10 non-Opec partners led by Russia to cut about 1.8 million bpd from October 2016 levels, in a bid to stabilise the oil market and boost prices. But the deal’s undoing could now be its success in pushing up oil prices too fast.

“If Opec and company deem the oil price too high and the US crude oil production growth too strong then they can and will do something about it. Yesterday we saw the first step of verbal intervention. Expect more of the same to come. If the market refuses to listen then they will put more supply into the market,” said Bjarne Schieldrop, chief commodities analyst at Nordic corporate bank SEB.

Andy Critchlow is head of energy news, Emea at S&P Global Platts