Will OPEC be forced to raise quotas since members produce as much as they want anyway?

Will OPEC be forced to raise quotas since members produce as much as they want anyway?

17 June 2019 from Mikael Syding

Will OPEC be forced to raise quotas since members produce as much
as they want anyway?
Energy drives the world, but despite the fact that oil reserves, oil production and oil demand only
move with a single percentage in one year, the oil price has recently made the stock market
look tame. OPEC, which will soon gather for an important meeting on June 25-26, recently
published statistics for 2018. Underlying fundamentals for the oil market undeniably look stable:

Production increased by 1.6% to its highest level ever, and the growth rate itself was the highest
since 2015. This was despite the fact that the OPEC countries reduced their production
somewhat, which was offset by the fact that the US has stepped up to become the world's
largest oil producer (before Russia and Saudi Arabia). According to OPEC, demand increased
by 1.5% in 2018 and proven oil reserves by only 0.4%.

Oil prices, however, have gone roller coaster last year:

Last autumn, for example, the Brent price plunged by 40% from $ 86 to $ 50, and WTI even
more from $ 76 to $ 43 a barrel (159 liters). Subsequently, prices rose by as much as 50% each
in the spring, to 74 (Brent) and $ 63 (WTI), driven by, among other things, stronger economic
data and unrest in the Middle East and South America.

Oil prices seem to be where the action is, if you want to capture large movements in clear
trends. The question is just how to know what is a fundamentally substantiated trend and what
is pure overreaction. Despite stable fundamentals, extremely small changes in supply and
demand seem to have extreme impact on the price. It is even so that the signal value of
potential production change is much more important than actual data. That is why the OPEC
meeting and the members' quota compliance are so important.

Many oil experts have been skeptical about the price increase this spring, but the correction of
minus 20% for both contracts in recent weeks has nevertheless surprised most people. Brent is
currently trading at $ 61 / barrel and WTI at 51. The downturn is particularly surprising given the
growing turmoil in the Strait of Hormuz, where several oil tankers have been attacked (by Iran,
according to the US) in June. Normally, otherwise, war risk in the Middle East and a threat to
transport through Hormuz means significantly rising prices.

How can you explain the recent fall in prices?

Perhaps the most important factor is precisely OPEC and its members. In ten days, at the
meeting at the headquarters in Vienna, discussions about the absence of production discipline
among some of the 14 members of the organization are likely to get hot.

Now that the United States beats production records on a continuous basis, while environmental
issues govern much of the world's agenda, it is unusually poor timing of Saudi Arabia and Iran
to indicate that they are capable of producing as much oil as they’d like for export.

The last month also has a poorer outlook for the economy in large parts of the world, which is
also reflected in expectations of interest rate cuts, which thus gives further reasons to believe in
falling oil prices. In the short term, rising oil stocks have emphasized unusually weak demand
for oil seasonally.

The lower the price falls, the more other members are forced to produce in order to balance
their budgets, leading to further downward pressure on the price until reaching the pain
threshold for the marginal oil producer. That level is probably much lower than 50 (WTI) and 60
(Brent) dollars per barrel, respectively, as evidenced by the oil price levels in 2016, so if the
unrest around Venezuela and Iran would slow down, the price could easily fall another 20%.

China's unexpectedly successful initiative to challenge the petrodollar system through oil trading
in Renminbi is also an important piece of the puzzle. Depending on how OPEC addresses this
issue, we can see the first steps towards increased decentralization of the oil market, and
ultimately perhaps even a dissolution of OPEC.

Given all other negative factors such as low growth, low interest rates, more efficient shale oil
production, etc., lower oil prices in the future seem more likely than higher. But above all, you
should probably expect continued large movements in both directions. Do you dare bet on the
outcome of the OPEC meeting on June 25? 

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24/07/2019 02:24:42


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