Less than two weeks before OPEC ministers gather in Vienna to decide the fate of crude production cuts beyond the March 2018 expiry of the current agreement, doubts have begun to surface about whether the organization will deliver on its promise.
From Saudi Arabia and Russia reiterating their commitment to rebalancing the oil market when King Salman visited Moscow in early October, to Saudi energy minister Khalid al-Falih repeating his "whatever-it-takes" mantra at an investment conference in Riyadh later that month, OPEC has been telegraphing its intent of continued restraint.
Oil bulls have had a few reasons to rejoice and push up benchmark Brent crude prices to a two-year peak above $64 per barrel. A sense of slowing growth in the U.S. shale sector and the appearance of a geopolitical "risk premium" on account of heightened tensions between Saudi Arabia and Iran have had much to do with the rally. However, the market's confidence that the Organization of the Petroleum Exporting Countries and its 10 non-OPEC collaborators will stay the course has also played an important part.
The best-case scenario factored in by the market in recent weeks -- probably even the base-case scenario for many -- is that the OPEC and non-OPEC cuts will be extended to December 2018. Comments by al-Falih, who holds sway over the bloc's policy as minister of OPEC's largest producer, have been particularly hawkish of late. The minister went so far as to suggest that active supply management could continue even after the immediate target of draining the world's bloated oil inventories has been achieved.
All on board?
But Russia might be about to throw a wrench in the works. Energy ministry officials and leaders of the country's state-controlled oil producers, following their discussions this week, have indicated that it might be too early to decide on an extension of the cuts when OPEC meets on Nov. 30.
As the world's largest crude producer and de facto leader of the 10 non-OPEC countries curbing supply alongside OPEC, it is important for Russia to be on board with any decision. It is not that OPEC cannot go it alone and finish the job it first undertook on the condition that a sizable number of major producers outside the group collaborate, but selling that idea to its own members would be a gargantuan, if not impossible, task.
The collective cut agreed by non-OPEC producers, at 558,000 barrels per day, is less than half of OPEC's own reduction. But faced with a formidable opponent in the nimble and technologically savvy U.S. shale industry, OPEC has insisted on the cooperation of other producers in restraining supply since it began formulating its new market management strategy last year.
As loathe as OPEC has been to giving the shale sector a "free ride" by profiting from higher crude prices, the organization has reiterated time and again that it would not want to do it for any other producers.
Russia may not be alone in wanting to be convinced of the need for a second full year of cuts. There have been suggestions from some OPEC ministers that they might agree to prolong the cuts but delay the decision on the duration to early 2018, though these headlines did not grab the imagination of a generally bullish market.
Debate among OPEC and non-OPEC producers over their supply management strategy is healthy. Complacency is not. If the producers, flush with crude's heady 40% climb above the year's nadir, start slipping on their quota discipline, or worse, persuade themselves that they can delay a decision on the extension, OPEC might be snatching defeat from the jaws of victory.
No matter how committed producers might be to ensuring that oil inventories among countries in the Organisation for Economic Co-operation and Development recede to a five-year average, the signal to the market would be that the producers may be standing down, or relaxing their guard, even before the objective has been achieved. Crude prices could take a pounding from worries of a renewed supply overhang.
Coincidentally or not, the run-up in crude prices through October saw eight of the 12 OPEC members participating in the cuts overshooting their quotas, with Iraq, Iran, the UAE, Angola and Ecuador being the major offenders. The group's overall adherence to its pledged reduction of around 1.16 million bpd was still strong, thanks mainly to the Saudis cutting back more than their share -- as they have been doing since January -- and output in financially embattled Venezuela on a slippery slope.
The idea that the cuts may not be needed beyond March 2018, no matter how fallacious, may prompt a further deterioration in the producers' adherence to their output limits.
Curiously, OPEC's November monthly oil market report -- which will serve as a reference point for the ministers gathered in Vienna -- took a surprisingly bullish turn from the view on supply-demand fundamentals just a month ago.
The latest report revised up the estimated annual global oil demand growth for 2017 to 1.53 million bpd, and for 2018 to 1.51 million bpd, up 80,000 bpd and 130,000 bpd from the October report, respectively. In doing so, it also diverged from the International Energy Agency, the Paris-based energy policy adviser to the developed world, which lowered both its 2017 and 2018 demand growth projections by 100,000 bpd, citing a milder 2017-18 winter and the dampening impact of higher oil prices on consumption.
OPEC's report also revised down the non-OPEC oil supply estimate for 2018, which when viewed together with expectations for average global oil demand rising to 98.45 million bpd, implies a bigger gap for OPEC crude to fill next year; one requiring more than a million barrels a day rise in output compared with 2017.
Other analysts are unlikely to go along with such a rosy picture of demand for OPEC oil next year. Even when OPEC believes it has evidence that the market is tightening, it will need to open the spigots gradually. It will always be easier to release more oil into the market if needed than reimposing restraints. Not putting a firm timeline on an extension of the cuts at the Nov. 30 meeting could prove to be a costly mistake.
Vandana Hari is founder of Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy commodities sector