Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

"Beyond" is a powerful word; the unsurpassed prefix to "compare" and the stirring suffix to "great." Buzz Lightyear even managed to somehow enhance the notion of infinity with it.

Seemingly, though, "beyond" loses much of its power when it comes to oil prices.

On Monday, Khalid Al-Falih, Saudi Arabia's Minister of Energy and Industry, said he was pretty confident the supply cuts agreed to in November by OPEC and some other countries would "be extended into the second half of the year and possibly beyond."

He surely knew people would seize upon that "possibly beyond." And they did, judging by the headlines the term generated -- especially as Al-Falih's Russian counterpart coincidentally (surely?) said much the same thing on the same day.

What about where it counts, though? Here's what happened to the front-month Brent crude-oil futures contract:

Speech Therapy
Signals suggesting OPEC's supply cuts might be extended into 2018 helped sustain a small recovery from last week's sell-off in Brent futures
Source: Bloomberg

So that "beyond" seems to have helped at the margin. And therein lies the problem.

To recap, when OPEC, Russia and some other countries announced their agreement on cuts in November, oil prices jumped. These stayed in the mid-$50s a barrel as cuts got underway in January and compliance with them was shown to be unusually high.

Since then, though, three things have happened:

So while OPEC and Co. began the process by saying the supply cuts would be implemented for six months and then potentially extended after a meeting in May, the coyness of that message has disappeared in recent weeks. Officials from the countries involved have spoken openly about that second six-month cut being essentially a done deal. Yet, it hasn't been enough -- hence Monday's upping of the ante to cuts possibly lasting into 2018.

There are two problems here.

One is the rapid debasement of OPEC's powers of persuasion. In less than six months, we've gone from cuts-and-maybe-an-extension, to cuts-and-of-course-an-extension, to all-cuts-all-the-time. And the oil price is still essentially where it was before OPEC announced at all.

The second problem is that signalling an extension into 2018 could ultimately undermine OPEC's strategy. I wrote here about how U.S. shale developers had used the pop in oil prices in December and January to hedge a lot of their expected 2017 production, thereby negating much of the impact of the supply cuts.

The same can't be said for 2018, where much of projected output is yet to be hedged. If Saudi Arabia and others actually succeed in jawboning longer-term oil futures noticeably higher, then U.S. rivals will certainly express their thanks in the form of more fracking. Thus far, though, 12-month oil futures seem unmoved.

If OPEC's members were focused on preserving the value of their oil reserves and comforted by their low operating costs per barrel, then they would let prices slide to a level that cleared out some higher-cost supply and boosted demand. Indeed, that's what they tried doing for roughly two years after November 2014.

What the crash has revealed, however, is that higher-cost rivals have been able to make themselves more competitive. In contrast, while many of OPEC's members can produce oil cheaply in a strict operating sense, each barrel must bear the burden of funding their unbalanced economies and frequently bloated public sectors.

Venezuela represents the tragic extreme. But even Saudi Arabia is struggling, as its "Vision 2030" reform program and plans to list shares in its national oil company attest. The country's recent restoration of state employees' bonuses was another notable u-turn in the face of implacably low oil prices -- and, it should be said, will be hard to re-reverse if things don't improve from here.

Either unwilling or unable to let the market clear, it seems OPEC still hopes it can muddle through until a supply crunch emerges to save the day. Judging from the increasingly coordinated messaging, Russia's participation is no longer a bonus but a necessity.

In an energy market that is changing in fundamental ways, though, these countries are essentially trying to hold back the tide. If cuts are their only strategy, then they must maintain them not just for now but well beyond -- maybe to infinity.

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

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net