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May 21, 2017

4 Potential Outcomes For Opec's Crucial Meeting: Here is the Summary of Article by Myra P. Saefong from MarketWatch - May 21, 2017.
Myra P. Saefong

OPEC will hold a highly anticipated meeting next week, with nearly everyone so far predicting that members will agree to extend production cuts at least through the end of this year.
But that’s not the Organization of the Petroleum Exporting Countries’ only option at its May 25 meeting in Vienna. Members will have to take a lot into account—including the initial public offering for part of Saudi Arabia’s state-owned oil company Saudi Arabia Oil Co., known as Saudi Aramco, planned for next year.
“The main, critical element in this market is the Saudi Aramco IPO,” Bodhi Ganguli, lead economist at Dun & Bradstreet, told MarketWatch in an interview. Saudi Arabia, OPEC’s biggest crude producer, will do its “best to keep prices at a level where it makes sense for them to have their IPO.”
So, the “Saudis are going to try their best to maintain the cuts at the very least,” and there is some chance that the cuts will be increased, said Ganguli.
OPEC members agreed late last year to cut collective production at the start of 2017 by 1.2 million barrels a day for six months. Non-OPEC producers, including Russia, also agreed to cut their output by another, roughly 600,000 barrels a day.
“The production cuts are providing a floor on [oil] prices,” said Ganguli. “Prices would have been lower if we did not have the production cuts.”
“Whether that’s exactly as OPEC members had wanted…or [whether] that’s enough to guarantee them higher market share down the line will be clear, of course, in the next few months,” he said.
A monthly report from the International Energy Agency released Tuesday pegged OPEC’s member compliance with the cuts at 96%—a historically high compliance rate for a group whose members had previously been known to cheat on production limits.
Despite the output reductions which kicked in at the start of the year, however, Brent oil prices LCON7, +0.91% the global benchmark, and U.S. benchmark West Texas Intermediate CLM7, +0.93% CLN7, +0.99%  have each lost roughly 8% year to date.
“In terms of delivering an initial boost to the price, the production cuts were successful,” said Ganguli. But in terms of whether this will be sustained—that would depend on “adherence to the supply cuts” and global demand expectations, as well as factors outside of OPEC’s control, including U.S. production, he said.
Probable outcome
OPEC is most likely to extend the current production-cut agreement by six months, Ganguli said, giving this scenario a 75% probability rate.
“This is what we have built into our price forecast for the year,” he said. Dun & Bradstreet expects Brent crude-oil prices to average $55 a barrel this year.
U.S. oil-rig counts have been going up, but production isn’t rising as rapidly as would be expected, because it takes time for the increased oil activity to translate into more barrels in the market, said Ganguli.
The global economy, meanwhile, is likely to improve in the second half of the year, and if that happens, would provide support to prices, he said. Given all of that, this “baseline” scenario makes sense.
“Even if we extend the cuts just at the current level, they should be enough to support the price in the range that we’re looking at—about $55 a barrel” for Brent, he said.
Possible outcomes
Still, there are three other unlikely, but possible outcomes for the OPEC meeting, according to Ganguli.
OPEC may just decide to end the output-cut agreement altogether, he said.
This would result in a slump in oil prices, said Ganguli, noting that he doesn’t have specific prices attached to this scenario because that would “depend on a large number of factors other than the OPEC decision itself.”
Overall, he sees this outcome as unlikely, with a 15% probability.
Compliance with the current cuts has been high—higher than Ganguli expected. And “there is some evidence that this is having an effect on global oil prices,” so the agreement producers have in place “seems to be working for now,” he said.
Then there’s the possibility that the agreement is extended, but with a “more stringent” cut, said Ganguli, pegging the chances of this happening at just 10%.
This would see prices increase from their present range in the short term, but there’s a big problem with this particular scenario: a price increase from putting more stringent output reduction requirements on members would create “an incentive to cheat,” he said.
There would be the “higher risk of a break down in the agreement to noncompliance,” said Ganguli.
This may also feed more oil investment in the U.S., and domestic production is likely to respond to that, he said.
Finally, OPEC may decide to extend the pact but lower the reduction requirement, said Ganguli, but the chance of that is set at just 5%.
Whatever the outcome of the much-anticipated meeting, oil producers will still face a dilemma.
“Medium-term risk” for the oil market comes into play after the Saudi Aramco IPO sometime next year, said Ganguli.
If prices drift significantly higher than the Dun & Bradstreet $55 forecast after the IPO, that will create incentive for some OPEC members to cheat, he said.
At that point, the Aramco IPO would be done, the Saudis may refuse to put up with noncompliance, the deal expires and then everybody starts producing more, including the Saudis,” he said. “That would pressure prices significantly again, and “that’s when the market share [issue] comes into place.”
OPEC will have to reassess the oil market—decide whether to extend the production cuts and take a close look at demand and global economic growth, said Ganguli.
“Oil markets…[are] never exactly balanced,” but for now, the market is “moving from an oversupply situation to some sort of balance,” he said—and a six-month extension to the output-cut deal will feed a drawdown in global supplies.