The Organization of the Petroleum Exporting Countries and its allies are taking a multi-layered bet that global oil dynamics will work in their favour by extending their crude oil production cuts until the end of 2018.
The group met market expectations by extending the combined 1.8 million barrels per day (bpd) of output cuts from their previous expiry of March next year at their meeting in Vienna on Thursday.
A commitment to exit the agreement gradually so as not to shock the market also sounded soothing, and it also appeared to give the impression that OPEC and its partners are firmly in control of what’s happening in global crude markets.
The reality is somewhat different, and for OPEC’s extended cuts to have the desired effect of rebalancing the crude market and keeping prices at least above $60 a barrel, other factors beyond their control will have to work in their favour.
There are two main elements, firstly demand from the fastest-growing major markets in Asia, namely China and India, and secondly, how much extra crude can producers outside the deal, most notably shale drillers in the United States, bring to global markets.
In some ways it’s almost an inevitability that the OPEC/non-OPEC production cuts will eventually work as demand growth can do most of the heavy lifting.
China, the world’s top crude buyer, has seen imports surge 11.8 percent in the first 10 months of the year, to the equivalent of about 8.4 million (bpd).
This represents an increase of 800,000 bpd over the 7.6 million bpd imported for 2016 as a whole, making China the major contributor to global demand growth.
Assuming China experiences similar demand growth in 2018, and OPEC and its allies do keep their output largely steady as a whole, this means that demand growth alone will substantially tighten the global market.
Of course, China’s import growth may not be as strong next year, as much will depend on whether the nation continues to fill its strategic reserves, on whether independent refiners are granted higher quotas to import crude and on whether the markets for China’s exports of refined products hold up.
The risk is that China next year looks more like India this year.
India, the world’s third-largest crude importer, has seen only modest growth this year, with imports up 1.2 percent to 4.34 million bpd in the first 10 months of the year, compared to the same period a year earlier.
This represents a much smaller than China’s contribution to global demand growth of just 51,000 bpd, making India a disappointment as far as crude exporters are concerned.
While there are reasons to be optimistic that India will perform better in 2018, such as forecast robust economic growth, the risk for OPEC and its allies is that both India and China surprise to the downside when it comes to demand growth.
On the supply side, the main factor outside the control of the OPEC/non-OPEC group is how much more U.S. shale oil will be produced, and will it remain competitive in Asia.
U.S. crude output rose to 9.48 million bpd in September, up 290,000 bpd from August and near the record 9.63 million bpd last seen in 2015. It was also the biggest month-on-month gain in five years.
That’s the sort of news that OPEC and its partners won’t want to hear, as it gives U.S. producers an opportunity to export more crude to Asia, especially since the discount of U.S. West Texas Intermediate to Brent crude is still over $6 a barrel, wide enough to make shipping across the Pacific or even around South Africa profitable.
U.S. crude is increasingly making itself felt in Asia, with vessel-tracking data showing about 135,000 bpd of exports in the first 10 months of the year, likely rising to 242,000 bpd in November and 379,000 bpd in December.
The rising crude price, with Brent closing at $62.63 a barrel on Thursday, will also incentivise other producers outside the OPEC/non-OPEC deal, such as Canada and Brazil, to boost output.
The risk for OPEC and its partners is that other exporters are able to meet any global shortfall in supply.
One area that is within the control of OPEC and its allies is their compliance with the agreement.
This has been high so far, and in public all parties state full commitment to the deal.
However, in the past OPEC has struggled to maintain production discipline over long periods of time, especially if crude prices are rising.
Perhaps the most perspicacious part of the OPEC/non-OPEC statement on Thursday was the part that acknowledged the “uncertainties associated mainly with supply and, to some extent, demand growth” next year.
For now, OPEC and its allies have done what they can, now they have to wait and see if the chips fall their way.