Pain, And No Gain

Saudis Are Right Back Where They Started

A lot of OPEC production sacrifice with little return.

Saudi Arabia has ended up with precisely what it wanted to avoid. Its output cut has left it supporting rival producers, while its sacrifice of volume has yielded little in the way of higher prices. Crude fell back on Thursday to levels not seen since before the producer group announced its historic oil output cuts on Nov. 30. What went wrong, and where do they go from here?

First things first. The oil price jumped after OPEC announced its decision to cut output by around 1.2 million barrels a day. It rose further when a group of non-OPEC countries joined them the following month.

The crude oil market barely batted a sleepy eyelid when the cuts began at the start of January. It rolled over with a gentle snore when the first month's production figures showed an almost unprecedented level of compliance of over 90% among the OPEC countries who were party to the deal.

Right Back Where We Started

Despite stellar compliance with output cut plans, OPEC's struggling to boost prices

Source: Bloomberg

Saudi oil minister Kahlid Al-Falih said last week that global oil stockpiles have been slower to decline than OPEC had hoped. In fact, they don't seem to be declining at all.

Total U.S. inventories of crude and refined products remain more than 20 percent above a five-year average level that includes the last two years of rising stockpiles. Comparing it with 2010-2014, the surplus is more than 30 percent higher than average.

In Europe, a 5.4 million barrel reduction in crude oil inventories in February was entirely offset by increases in gasoline and middle distillates, according to Euroilstock data. Meanwhile, China built crude oil stockpiles by nearly 30 million barrels last month, according to analysis by Vienna-based consultants JBC Energy.

Drowning in Oil

OPEC cuts have had no impact on U.S. stockpiles of crude and refined products

Source: Bloomberg

The effectiveness of the agreed output cuts has been undermined by the failure of some to reduce output as they pledged and by rising production from Libya and Nigeria, who were excluded from the deal. But the biggest impact has come from the surge in U.S. production that was beginning even as the cuts were being discussed.

The Department of Energy sees average daily U.S. production increasing by a relatively modest 330,000 barrels in 2017 from 2016. But the increase between October 2016 -- the baseline month for OPEC's cuts -- and December 2017 is a much more substantial 740,000 barrels. It is this that is causing problems for OPEC.

Diminishing Impact

Effective cuts have been halved by non-compliance and rising output elsewhere

Source: Bloomberg

So what does Saudi Arabia do now? Al-Falih's position on extending the cuts has shifted. Six weeks ago he said an extension was unnecessary; last week, speaking at IHS Markit's CERAWeek conference in Houston, he opened the door to the possibility of a rollover.

However, he also warned that fellow OPEC members couldn't count on the kingdom to continue shouldering a disproportionate share of the burden. "We’ve been willing to do it for the front end but we expect our friends and partners to pick up the slack as we move forward," he said.

The warning should be taken seriously. One thing that has remained consistent throughout Saudi Arabia's policy shifts since Nov. 2014 is its insistence that the burden of balancing the market must be shared. That view was aired again last week.

The kingdom won't walk away from last year's deal, but it is preparing the ground to take a tougher line when discussions turn to what to do next. If there is no sign of more widespread compliance with agreed cuts, or that those cuts are starting to have the desired effect, Saudi Arabia's return to active market management could prove shorter lived than its experiment with a free market in oil.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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