Editorial

OPEC's dilemma

When should the organisation lift production restraint?

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A further extension of three months to the end of Q1 2018 reduces the downward price impact of seasonally weak oil demand. OPEC's dilemma is: when should it return its volume to the market, and how fast can US tight oil grow due to a more supportive price environment?

Alan Gelder, Vice President Refining, Chemicals and Oil markets

Alan Gelder

VP Refining, Chemicals & Oil Markets

Alan leads our global refining and oil marketing research; he manages our refining and chemicals outlook in EMEARC.

View Alan Gelder's full profile

With OPEC agreeing to roll over production for nine more months, our 2017 oil price forecast of US$55/bbl for Brent is largely unaffected. But as fundamentals tighten in the second half of 2017, we believe a firmer oil price will further support the US tight oil industry.

"Today's decision in Vienna sends a signal of continued support for oil prices from OPEC, which helps US onshore drillers make plans," says Ann-Louise Hittle, Vice President, Research Macro Oils. She added: "The extension through to the first quarter of 2018 makes it clear to the oil market that OPEC intends to continue to support oil prices at the expense of market share, at least for the time being."

With oil prices at or above US$55/bbl during 2018, rig additions in all tight oil plays would be higher than in our base case scenario.

Pre-meeting analysis

In November 2016, OPEC reversed course on its strategy to seek market share and agreed, with the support of additional non-OPEC countries, to cut production and support higher oil prices. After six months and a dramatic recovery in the US, OPEC is gathering again in Vienna to announce whether production restraint will continue — and for how long.

Global supply could surge in 2018 if current production cuts aren't rolled over through H2 2017 and extended into 2018.

Global supply could surge in 2018.

The decision coming out of the upcoming meeting presents a tricky balancing act: how best can OPEC reintroduce its supply over time while avoiding oversupply and a sharp fall in oil price? Our leading experts in oil price examine four options for OPEC as it gathers in Vienna this week.

Back in January 2017, we argued that OPEC would roll over its agreement through H2 2017. On that basis, we forecast Brent would average US$55 per barrel (bbl) this year.  We analysed 2018 on the basis of no production cuts next year. The annual average price for Brent was forecast at US$50/bbl on this basis because, as the chart above shows, total oil supply would grow 2.4 million b/d in 2018 compared with world oil demand growth of 1.2 million b/d year-on-year in 2018. 

If OPEC stops trying to support oil prices and seeks market share instead, we would see OPEC and Russian production start to rise in H2 2017 and continue to increase next year. This would put significant pressure on prices, which could fall to an annual average of US$43/bbl for Brent in 2018. While we do not believe this outcome likely, examining the risk of it highlights the significance of the current agreement to the market.

In the run-up to the meeting, some members within OPEC briefly considered the option of deeper cuts on top of the production restraint already in place. The benefit would be a larger implied stock draw in Q3 2017 than we currently forecast — potentially as much as 1.8 million barrels per day (b/d) — helping to clear current oversupply. This would lead to higher prices in the second half of this year, with Brent forecast to rise just above US$60/bbl at the end of the year.   

However, OPEC is currently discussing a Saudi-Russia proposal to extend the existing production cut agreement through Q1 2018. To date, this is the most likely outcome from the 25 May meeting, but it is a fluid situation with negotiations underway in Vienna. A nine-month extension would have little impact on our price forecast for 2017 at an annual average of US$55/bbl for Brent. Into 2018, we expect Brent would average at least US$55/bbl on a monthly basis. With oil prices at or above US$55/bbl during 2018, rig additions in all tight oil plays would be higher than in our base case from 3 May.

For a year-on-year comparison, US production would rise 0.95 million b/d in 2018, or 150,000 b/d higher than if the rollover were only extended for 6 months, through H2 2017.  The rate of US production growth in H2 2018 would be the fastest seen since the recovery started, with consecutive months of 100,000+ b/d of growth.

Finally, OPEC could also extend the existing agreement through the whole of 2018. Although this scenario would have little effect on our near-term base case, it would lead to a tighter supply/demand balance through 2018. The annual average for Brent in 2018 could be as high as US$63/bbl. Prices holding above US$60/bbl means stronger investment in almost all US tight oil plays. The trajectory of our rig forecast in this case suggests annual growth rates of over 1 million b/d are easily achievable in 2019 to 2021.

For further discussion on the implications of latest OPEC decision, follow us on Twitter @WoodMackenzie.

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