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Opec faces quandary as cuts fail to hold up prices

With the oil market showing signs of losing faith in a price rebound, Opec is now asking itself: what more can it do?

Production cuts agreed late last year between some of the world’s biggest producers inside and outside the cartel, are losing their sway given the near 10 per cent drop in the Brent benchmark over the past week. Brimming global storage tanks and a resurgent US shale industry are casting a shadow over the oil market with prices erasing all their gains since Opec and producers such as Russia agreed a supply cut dea

Opec delegates, facing a familiar conundrum, question how painful a return to its old playbook of supporting the oil market will be. Having spent two years prioritising export volumes over price, it is now losing out on both.

Saudi Arabia-led Opec has repeatedly said the cartel will not cut production in response to a structural shift in the market, yet this is exactly the position it is in. A battered economy and a planned public offering of Saudi Aramco, the state energy giant in 2018, forced the kingdom’s hand.

Its concerns have been displayed starkly as shale drillers — more efficient and stronger since the downturn — came surging back as prices rose after near-full compliance with the supply cut deal.

“It was obvious that with a reversal in prices, the US shale production was going to pick up. But the magnitude of the improvement was really not known,” says one Gulf delegate, suggesting Opec is again on the back foot.

Regardless of how painful the current effort to reduce excess inventories and prop up prices is, holding firm is the only option to prevent a further price plunge.

Saudi Arabia, which has led the cuts, recognises this. A rare statement from the kingdom saying it was committed to the deal halted a slide in prices towards $50 a barrel this week amid fears it was backing away from pledges.

As Opec delegates strive for the $55-$60 a barrel range, they are looking to the group’s next move. At a Vienna meeting in May, the group will decide whether to abandon, extend or deepen production cuts.

“Ultimately Opec needs to decide to renew the cut agreement,” says a delegate from a Middle Eastern producer. He added that until the stock drawdown gathers pace, it is crucial to bolster prices.

The impossible balancing act is one that Opec has wrangled with since the oil downturn got under way in mid-2014: how to drain global stockpiles and prop up prices without unleashing vast supplies from rivals.

“As prices go up, you attract a lot of producers back. This has become the reality. With US shale producers and others, you certainly can’t just get rid of them. That much is clear,” says one delegate from an African country. Striking a pessimistic tone, he adds: “The era of high oil prices is over for the time being. And maybe for good.”

Others in Opec have dismissed the recent price drop as a short-term panic and say it is too soon to say how the market will play out.

Although hopes of a swift impact of output cuts on the market have damped, the International Energy Agency forecasts a supply and demand balance by mid-2017 even with non-Opec growing output by 400,000 barrels a day this year.

Some analysts say the expectation of a fast stockpile reduction is misguided given the huge overhang, largely created by a surge in Opec’s own output late last year.

Amrita Sen, chief oil analyst at Energy Aspects, says that after dramatic cuts to production in 2008 — the last time Opec curbed production collectively — it took until the first quarter of 2011 for stockpiles to deplete and for the futures curve to move into backwardation. This is when the Front-month is at a premium over the year-ahead contract, suggesting the market is no longer in surplus.

“But this time the excess stockpiles are a lot greater. In 2008 inventory overhang was 150m barrels of just crude. This time, according to our numbers, it’s 250m,” says Ms Sen.

Last time, prices dramatically picked after the depths of the financial crisis, as fears swirled that China’s fast-growing demand could spur shortages. The US shale boom makes this less of a concern in the short term.

“Even though fundamentals are shifting, people have underestimated the sheer level of excess inventories,” she says, adding that oil was first coming out of storage on ships before onshore tanks.

As Opec waits, some delegates have resorted to soul searching, worried that a production deal has only a limited effectiveness. Another concern is convincing Russia to once more take part in another round of commitments.

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Rosneft, the country’s biggest producer, has already signalled Russia may be unwilling to contribute. “There are risks of non-extension of the agreement, related both to the will of the main participants and to the dynamics of shale mining in the US,” says a spokesperson for the company, who warned of a new price war.

With two months remaining before the May meeting, Bill Farren-Price at Petroleum Policy Intelligence says maintaining its current stance is Opec’s only course.

“By not renewing they would be telling the world Opec supply restraint doesn’t work. The cost of changing tack is too great,” he says. “At this stage it’s about doing whatever you can to defend the price, let alone increase it.”

Additional reporting by Henry Foy

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