There are things brewing within OPEC. At a meeting in Baku, Azerbaijan last week – which was meant to set the stage for a formal meeting in April to review the current supply deal among the 24-country OPEC+ block – the conclusion of the meeting was that the April meeting would be deferred. The review will now take place at OPEC’s regular meeting in Vienna in June, which is mere days before the current supply deal is scheduled to end. That’s cutting it close, but more interesting for market observers is that it points to the Saudi Arabia-Russia bromance souring.
Prior to the meeting, Saudi Arabia had gone on record to state that the Kingdom believed that OPEC’s job in rebalancing the oil market was far from over and that output cuts were necessary to continue into the second half of 2019. Defying US President Donald Trump’s Twitter tantrums – especially with the Kingdom implicated in the assassination of Saudi dissident Jamal Khashoggi – Saudi Arabia is firmly behind continuing restricted supply. In the past, Saudi Arabia would most likely to be able to bully its way into an OPEC consensus. But now, it has to deal with an equally powerful 20-ton gorilla in the same room: Russia.
The success of the OPEC+ club over the past two years has been down to this close relationship between the world’s two largest oil producers. This had allowed crude prices to recover from sub-US$50/b levels. But the latest meeting is also the latest sign that all may not be well in the friendship. First, a joint Saudi-Russia meeting at the World Economic Forum in Davos was called off. Second, February data showed that while Saudi Arabia and its allies were doing far more than necessary to cut their crude production, Russia was shuffling its feet with less than 50% adherence, claiming that it needed more time to implement the cuts. And last week, despite Saudi Arabia lobbying for an extension to the cuts and general backing from members including Iraq, Russian Energy Minister Alexander Novak was in opposition. The official reason was that OPEC+ would need clarity on market situation before planning the next move, given the disruption brought about by ongoing and developing American sanctions on Iran and Venezuela. In the absence of necessity, the two crude powerhouses have drifted back to their default positions: Saudi Arabia’s aggression and Russia’s conservatism.
So while the world waits and watches for OPEC+’s next move, the market is analysing the potential impact of a strained Saudi-Russia relationship. But necessity might bring the two back together again, since they now face a common foe – rising US crude production. OPEC’s secretary general recently met with key executives in the US shale oil industry. This was billed as a ‘friendly conversation on current industry trends’ and interpreted as an attempt to cajole American shale producers in a mutually-beneficial stabilisation of the market. It is ridiculously unlikely for the US to ever join the OPEC+ club, but if the move could convince US shale firms to temper their expansion to prevent global oversupply, it might be worth it. Because OPEC has accompanied the olive branch with a threat – if OPEC does all the work to stabilise markets only to have American shale take advantage of the situation, it could very well reverse its stance and turn the OPEC tap on full to swamp the market once again. It’s a classic example of game theory, and one to watch as the power dynamics of global oil continue to change.
Key upcoming dates for OPEC:
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Working natural gas inventories in the Lower 48 states totaled 3,519 billion cubic feet (Bcf) for the week ending October 11, 2019, according to the U.S. Energy Information Administration’s (EIA) Weekly Natural Gas Storage Report (WNGSR). This is the first week that Lower 48 states’ working gas inventories have exceeded the previous five-year average since September 22, 2017. Weekly injections in three of the past four weeks each surpassed 100 Bcf, or about 27% more than typical injections for that time of year.
Working natural gas capacity at underground storage facilities helps market participants balance the supply and consumption of natural gas. Inventories in each of the five regions are based on varying commercial, risk management, and reliability goals.
When determining whether natural gas inventories are relatively high or low, EIA uses the average inventories for that same week in each of the previous five years. Relatively low inventories heading into winter months can put upward pressure on natural gas prices. Conversely, relatively high inventories can put downward pressure on natural gas prices.
This week’s inventory level ends a 106-week streak of lower-than-normal natural gas inventories. Natural gas inventories in the Lower 48 states entered the winter of 2017–18 lower than the previous average. Episodes of relatively cold temperatures in the winter of 2017–18—including a bomb cyclone—resulted in record withdrawals from storage, increasing the deficit to the five-year average.
In the subsequent refill season (typically April through October), sustained warmer-than-normal temperatures increased electricity demand for natural gas. Increased demand slowed natural gas storage injection activity through the summer and fall of 2018. By November 30, 2018, the deficit to the five-year average had grown to 725 Bcf. Inventories in that week were 20% lower than the previous five-year average for that time of year. Throughout the 2019 refill season, record levels of U.S. natural gas production led to relatively high injections of natural gas into storage and reduced the deficit to the previous five-year average.
The deficit was also decreased as last year’s low inventory levels are rolled into the previous five-year average. For this week in 2019, the preceding five-year average is about 124 Bcf lower than it was for the same week last year. Consequently, the gap has closed in part based on a lower five-year average.
Source: U.S. Energy Information Administration, Weekly Natural Gas Storage Report
The level of working natural gas inventories relative to the previous five-year average tends to be inversely correlated with natural gas prices. Front-month futures prices at the Henry Hub, the main price benchmark for natural gas in the United States, were as low as $1.67 per million British thermal units (MMBtu) in early 2016. At about that same time, natural gas inventories were 874 Bcf more than the previous five-year average.
By the winter of 2018–19, natural gas front-month futures prices reached their highest level in several years. Natural gas inventories fell to 725 Bcf less than the previous five-year average on November 30, 2018. In recent weeks, increasing the Lower 48 states’ natural gas storage levels have contributed to lower natural gas futures prices.
Source: U.S. Energy Information Administration, Weekly Natural Gas Storage Report and front-month futures prices from New York Mercantile Exchange (NYMEX)
Headline crude prices for the week beginning 14 October 2019 – Brent: US$59/b; WTI: US$53/b
Headlines of the week
Amid ongoing political unrest, Ecuador has chosen to withdraw from OPEC in January 2020. Citing a need to boost oil revenues by being ‘honest about its ability to endure further cuts’, Ecuador is prioritising crude production and welcoming new oil investment (free from production constraints) as President Lenin Moreno pursues more market-friendly economic policies. But his decisions have caused unrest; the removal of fuel subsidies – which effectively double domestic fuel prices – have triggered an ongoing widespread protests after 40 years of low prices. To balance its fiscal books, Ecuador’s priorities have changed.
The departure is symbolic. Ecuador’s production amounts to some 540,000 b/d of crude oil. It has historically exceeded its allocated quota within the wider OPEC supply deal, but given its smaller volumes, does not have a major impact on OPEC’s total output. The divorce is also not acrimonious, with Ecuador promising to continue supporting OPEC’s efforts to stabilise the oil market where it can.
This isn’t the first time, or the last time, that a country will quit OPEC. Ecuador itself has already done so once, withdrawing in December 1992. Back then, Quito cited fiscal problems, balking at the high membership fee – US$2 million per year – and that it needed to prioritise increasing production over output discipline. Ecuador rejoined in October 2007. Similar circumstances over supply constraints also prompted Gabon to withdraw in January 1995, returning only in July 2016. The likelihood of Ecuador returning is high, given this history, but there are also two OPEC members that have departed seemingly permanently.
The first is Indonesia, which exited OPEC in 2008 after 46 years of membership. Chronic mismanagement of its upstream resources had led Indonesia to become a net importer of crude oil since the early 2000s and therefore unable to meet its production quota. Indonesia did rejoin OPEC briefly in January 2016 after managing to (slightly) improve its crude balance, but was forced to withdraw once again in December 2016 when OPEC began requesting more comprehensive production cuts to stabilise prices. But while Indonesia may return, Qatar is likely gone permanently. Officially, Qatar exited OPEC in January 2019 after 48 years of continuous membership to focus on natural gas production, which dwarfs its crude output. Unofficially, geopolitical tensions between Qatar and Saudi Arabia – which has resulted in an ongoing blockade and boycott – contributed to the split.
The exit of Ecuador will not make much material difference to OPEC’s current goal of controlling supply to stabilise prices. With Saudi production back at full capacity – and showing the willingness to turn its taps on or off to control the market – gains in Ecuador’s crude production can be offset elsewhere. What matters is optics. The exit leaves the impression that OPEC’s power is weakening, limiting its ability to influence the market by controlling supply. There are also ongoing tensions brewing within OPEC, specifically between Iran and Saudi Arabia. The continued implosion of the Venezuelan economy is also an issue. OPEC will survive the exit of Ecuador; but if Iran or Venezuela choose to go, then it will face a full-blown existential crisis.
Current OPEC membership: