Is Weakness Short-term Or Lasting?

As OPEC and its allies meet this week in Vienna, there is broad anticipation that they will seek to reassure nervous markets with additional production cuts. Expectations that next year will see a growing surplus if nothing is done have already caused some price weakness, although talk of a tougher line has raised prices in the past few days. It is guaranteed that calls for stricter compliance will be made, since they always are, and the attention will be on Iraq and Russia, the only two major producers who are noticeably out of compliance. 

Many think that the Saudis are focused on the Saudi Aramco IPO, occurring this week, meaning they will adopt a tough stance on over-producers as well as seeking an increased production cut. It will be interesting to see if they seek particularly sharp cuts, especially in the first half of 2020. The figure below shows how the market is expected to be especially weak in the 1st quarter, with recovery (in demand for OPEC oil) in the third quarter. 

The problem for OPEC (and most humans) has always been differentiating between long-term market trends and short-term deviations from them. This is even more true now that there is so much uncertainty about U.S. shale oil production: drilling is done sharply this year and many predict either weaker growth or even a peak, while others foresee new pipeline takeaway capacity yielding higher returns and renewed investment. The figure below shows how the longer-term trend in OPEC’s market share which has weakened for years, somewhat reminiscent of the early 1980s (albeit milder), but again, given the importance of rising shale oil production in the recent decline, and an expectation that the boom days are behind us, the trend might not hold in coming years. 

The fact that industry pundits were nearly unanimous in the early 1980s that the market was on the verge of a turnaround (in favor of producers), will make many old-timers wary of the recent slide. Some OPEC ministers, notably Saudi Minister bin Salman, are very familiar with that history, while others are more in the nature of politicians with only minimal experience on the specific nature of oil markets. As with commodity producers generally, they will anticipate brighter days in the future. (Hope springs eternal in the human breast, as energy economist Alexander Pope said.)

Typically, OPEC focusses on the near-term market in setting quotas (or production targets, to be politically correct), so the trends shown in the first figure are likely dominating their thinking, and with the Aramco IPO coming up, the Saudi delegation will probably adopt a similar pose. Longer term, though, the fact that OPEC’s market share has been declining steadily suggests trouble in the future. It can be the near-term future if Iran and Venezuela manage to evade American sanctions.

But the trend right now, and the uncertainty about U.S. shale production longer term, implies that no one (read: Saudi Arabia) is going to pull the trigger on a new price war. Prices should continue to be range bound over the next couple of quarters. 

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