Energy

Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

OPEC ministers failed in their attempt to convince the market that they have a plan when they agreed to extend output cuts for another nine months. The extension wasn't a problem -- it was the lack of a sense of what comes next.

By the time officials had retreated to their Vienna hotels on Thursday, or fled to the airport, the price of crude had fallen by 4 percent.

Market Verdict
Crude oil dropped after the output agreement
Source: Bloomberg
Note: Intraday times are displayed in ET.

The extension was supposed to show an unprecedented degree of cooperation between the Organization of Petroleum Exporting Countries and a group of non-member producers. It was meant to demonstrate a commitment to do whatever is necessary to bring inventories down to their five-year average level. But as I noted last week, it's a pale imitation of previous interventions.

What the deal lacked, rather than what it contained, proved its weakness.

There was no clarity on how the process of rebalancing the market might end. What happens when inventories are back where OPEC wants them? According to Saudi Energy Minister Khalid Al-Falih, that will be by the end of the year. But he clearly wasn't using OPEC's own market analysis to make that prediction, because the group is much less optimistic than the International Energy Agency about the drawdown of stockpiles in the second half, based on current production levels.

Who's Right?
OPEC must hope the IEA's aggressive forecast of stock draws is more accurate than its own
Sources: Bloomberg, OPEC, IEA
Note: Positive numbers indicate a stock build, negative ones a draw.

The fear is that the group will return to the production free-for-all that we saw between November 2014 and the start of this year, triggering another round of excessive stockpiling and another price collapse.

OPEC failed to address those concerns with any conviction. That's a pity, because it could so easily have done so. As long as the group's own members are prepared to ease their output cuts gradually, there should be little difficulty in unwinding the reductions made by others.

Around one-third of the cuts offered by non-OPEC producers came from natural declines that can't be reversed. Mexico and Azerbaijan both fall into that category. For the others, particularly Russia, there would be no incentive to flood the market with unwanted crude -- in all probability those producers also would be willing to raise output at a gentle pace.

Involuntary Cuts
Around one-third of the non-OPEC cuts come from natural decline and can't be reversed
Source: Bloomberg

So why don’t people who trade oil believe them? The experience of unfettered OPEC production in 2015 and 2016 has left them scarred. The slump in prices from above $110 per barrel to less than $30 in the space of 19 months wiped billions of dollars off the value of funds that invested in oil and of the companies that produce it.

Fear of a repetition, just as the industry is finding its feet again, looms large.

History Lesson
Unrestrained OPEC production in 2015 and 2016 hammered prices
Source: Bloomberg

Al-Falih said after the meeting that he was not concerned by day-to-day fluctuations in the oil price -- which is just as well. He insisted that the strategy is the right one. Producers can't control the price, he said, they can only control supply and, through that, inventories and that's what they would focus on.

The market begged to differ. OPEC squandered an opportunity to give clear direction on its longer-term strategy, leaving oil traders with the impression that the group doesn't have one. That failure will be costly, at least in the short term.

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

To contact the author of this story:
Julian Lee in London at jlee1627@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net