May 8, 2017 / 11:11 AM / 2 months ago

COLUMN-OPEC signals cuts extension, oil traders ponder response: Kemp

5 Min Read

(John Kemp is a Reuters market analyst. The views expressed are his own)

By John Kemp

LONDON, May 8 (Reuters) - Saudi Arabia’s energy minister has indicated OPEC will extend its current production cuts for at least another six months to the end of 2017 and maybe further.

“Based on consultations that I’ve had with participating members, I am confident the agreement will be extended into the second half of the year and possibly beyond,” Khalid al-Falih said on Monday.

“I believe the worst is now behind us with multiple leading indicators showing that supply-demand balances are in deficit and the market is moving towards rebalancing,” Falih told an audience in Kuala Lumpur.

“We should expect healthier markets going forward,” he said (“Saudi energy minister says may extend oil output cuts beyond 2017,” Reuters, May 8).

From the beginning, oil producers envisaged the agreement on production cuts might need to be extended to rebalance the oil market fully.

OPEC’s original agreement on revised production levels was reached on Nov. 30 last year and always subject to review in the normal way at the organisation’s next scheduled ministerial conference on May 25.

OPEC’s subsequent agreement with non-OPEC producers made this explicit by stating output would be cut from Jan. 1 for six months with the option to extend the curbs for a further six months.

Earlier this year, Saudi officials cast doubt on whether an extension would be necessary given high levels of compliance with the agreement.

Falih told reporters in January an extension would probably not be needed ("Saudi energy minister: unlikely to extend producers' agreement," Reuters, Jan. 16).

"My expectations (are) that the rebalancing that started slowly in 2016 will have its full impact by the first half," he said.

"Based on my judgement today it's unlikely that we will need to continue (the agreement) - demand will pick up in the summer and we want to make sure the market is supplied well. We don't want to create a shortage or squeeze."

But as global crude stocks remain high and prices come under renewed pressure, Riyadh seems to have concluded an extension is inevitable to drain excess inventories and restore confidence.

Saudi and other officials from the Organization of the Petroleum Exporting Countries have been dropping increasingly strong hints in recent weeks that an extension was likely, even while they tried to keep their options open.

However, with hedge funds turning bearish and oil prices giving up most of their post-agreement gains last week, the need for a clearer signal has become urgent.

With hedge funds embarking on a fresh cycle of short selling in oil, OPEC ministers seem to have concluded it was no longer practical to wait another two weeks until their formal meeting on May 25.

Most oil traders had already concluded that OPEC had no option but to extend the production cuts so the clearer language from Falih and other ministers is unlikely to shift expectations.

What was new was Falih’s willingness to contemplate extending the agreement even further, beyond 2017.

Some analysts have concluded even a six-month extension would not be enough to bring stock levels down to their long-run average.

In their view, production cuts would need to be extended into the middle of 2018, a concern Falih acknowledged implicitly.

Whether Falih’s comments are bullish or bearish for oil prices is mostly a matter of perspective: is the barrel half full or half empty?

From a bearish perspective, Falih admitted what many oil analysts have been saying: market rebalancing is taking longer than expected at the start of the year.

From a bullish perspective, Falih confirmed Saudi Arabia and other oil producers are prepared to do "whatever it takes" to bring global crude inventories back to the five-year average.

If OPEC decides to roll over its current agreement for a further six months without substantial changes when ministers meet on May 25, the decision may not boost prices much, though it could stop them weakening further.

In the past, oil prices have risen significantly in the aftermath of an announcement by OPEC that it is cutting production, according to researchers, who examined all OPEC announcements between 1983 and 2008.

But rollovers generally had little impact on prices or even a slightly negative effect (“The behaviour of crude oil spot and futures prices around OPEC and SPR announcements,” Demirer and Kutan, 2010).

“If OPEC announces a production cut, the surprise leads to an upward adjustment in prices ... However, if they maintain the status quo, the market takes this as a failure to agree on a production cut and therefore adjusts prices downward.” (Editing by Dale Hudson)

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