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Understanding Saudi Arabia's tough talk at OPEC

April supply cuts were respected by almost all the member states, but there are signs of racks emerging.

Last week’s virtual meeting of oil ministers from the OPEC+ alliance was a fascinating insight into the role Saudi Arabia, and in particular its oil minister Prince Abdulaziz Bin Salman, plays in the organisation.

It opened with Prince Abdulaziz reminding his counterparts about the importance of honouring any oil output cuts they agree to – not as an act of charity but as a vital commitment to maximising each member country’s profits. It can’t have been a particularly comfortable lecture for some of the member states to listen to.

It turns out that the new OPEC - where members are meant to be in it all together, sticking to output targets and making up for any shortfalls with deeper compensatory reductions - might be starting to show similarities to the old OPEC, which was often marred by a failure to adhere to supply agreements.

During the first four months of the deal OPEC+ struck in April implementing record output cuts, the 10 OPEC countries bound by the pact – plus 10 more from outside the group – pumped just 12.7 million barrels more than they agreed. That puts the overall compliance rate at just over 98 percent, an astonishingly high figure for a group with a reputation for missing its targets by a wide margin.

Saudi Arabia’s oil minister deserves the credit for that, but there are other factors at play. The outstanding compliance rate has only been achieved thanks to additional voluntary cuts made by the kingdom and its closest allies, Kuwait and the UAE, that totalled 1.18 million barrels a day in June.

Without those cuts, the group’s overproduction would have been a far more significant 48.1 million barrels, putting compliance at a less impressive 93 percent.

That’s still pretty good by historical comparison. Compliance with the output cuts introduced in January 2009, for example, never exceeded 70 percent, according to data compiled by the Centre for Global Energy Studies.

Warning shots

Having opened the meeting by publicly rebuking the group, the Saudi minister closed with dire warnings to oil traders who might bet on crude prices falling. Potential short sellers should not bet against OPEC because the group would be “proactive and preemptive” to stop supply running ahead of demand. “I want the guys in the trading floors to be as jumpy as possible. I’m going to make sure whoever gambles on this market will be ouching like hell,” he said.

So why the combative tone? There are two schools of thought about the state of the oil market, encapsulated in the differing views from the world’s two biggest independent oil trading companies, Vitol Group and Trafigura Group.

In the view of Vitol CEO Russell Hardy, oil inventories that have been falling sharply will continue to decline over the rest of the year. About a quarter of the stockpile built up in the early summer has already been used up and another quarter will be drawn down by year-end, he said in an interview during the Asia Pacific Petroleum Conference (APPEC) last week.

Senior executives at Trafigura see the world rather differently. “I remain concerned about the oil market for the next three to six months,” CEO and chairman Jeremy Weir said last week. He was echoing comments by the company’s co-head of oil trading, Ben Luckock, who told the APPEC gathering that he was in “no hurry to be involved in a recovery trade.”

“We’re in a supply-heavy market,” he said, adding that he expects crude stockpiles to build for the rest of this year and Brent prices to “drift into the high $30s.”

Talking the Market Up

After all, the outlook from the world’s three major oil forecasting agencies has taken a turn for the worse over the past month as the Covid-19 pandemic continues to take a toll on demand. The International Energy Agency, OPEC and the US Energy Information Administration all now see oil stockpiles falling more slowly than they did back in August.

Can the Saudi oil minister convince traders that OPEC will keep the market in Vitol’s world? Oil prices jumped, but his protestations suggest he may fear we could find ourselves in the world sketched out by Trafigura soon enough.

Seen in that light, his fixation on securing compensatory cuts from OPEC+ members who’ve failed to meet their targets is understandable. But that compensation is getting pushed further and further into the future. Last week, it was recommended by the committee he co-chairs that the deadline for making up the shortfalls be extended by three months to the end of the year.

Unless he can get a grip on OPEC’s free riders, his new OPEC is going to look very much like the old OPEC, where Saudi Arabia bore the lion’s share of the burden of balancing the market. That may not be sustainable.

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