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Positions and actions taken by Saudi Arabia and Iraq argue for an extension of the OPEC cut deal into the second half of the year. But will KSA agree to a rollover if its cut is being replaced by Iraq's production?

Saudi Arabia

Saudi Energy Minister Khalid Al-Falih said that OPEC would extend the cuts after they expire in June if oil stockpiles were "still above the five-year average." However, he said it was too early to know whether they would be down to that average by June.

Khalid al-Falih. Photo: Bloomberg.

Saudi Arabia will not allow itself to be used by others. My colleagues have heard that privately, and I am saying it publicly we will not bear the burden of 'free rides.'"

Mr. Al-Falih had said in a press conference in December, that KSA had limited its tanker nominations in-line with the agree-upon cuts. But U.S. import data show that crude oil from Saudi Arabia had jumped from the December baseline, and were significantly higher than a year ago. The data disprove what he said in December.

Furthermore, OPEC reported its production for February, and Saudi Arabia reported output at 10.011 million barrels per day, a gain of 263,000 b/d from January. The level was still in full compliance but underscored his recent message about not being used.

Although he said he did not know if the extension would be needed, data from OPEC and the Energy Department clearly show that OECD inventories will remain far above the 5-year averages, which are rising due to the persistence of high inventories.

Based on February production (as reported by the individual members), global demand and non-OPEC supply implies a "call" on OPEC oil. Assuming OPEC production continues at the February level as reported by members, global stocks would build by over 200 million barrels in the first half of 2017.

1Q

2Q

Demand

94.8

94.9

Non-OPEC

63.8

63.3

Call On OPEC

31

31.6

OPEC Prod

32.541

32.541

Stock Ch

1.541

0.941

Stock Ch

138.7

84.7

If the lower production level reported by secondary sources is used, inventories will still build by over 100 million barrels.

1Q

2Q

Demand

94.8

94.9

Non-OPEC

63.8

63.3

Call On OPEC

31

31.6

OPEC Prod

31.959

31.959

Stock Ch

0.959

0.359

Stock Ch

86.3

32.3

Projections by the U.S. Dept of Energy show that OECD stocks will build by 26 million barrels from December 2016 through the end of June. There is little doubt that an extension of the deal would be needed under the Saudi minister's criterion.

Finally, Saudi Prince Mohammed bin Salmon met with President Trump last week. The "readout" from the meeting stated:

On energy, the two countries affirmed their desire to continue bilateral consultations in a way that enhances the growth of the global economy and limits supply disruption and market volatility."

I interpret this to mean that Saudi Arabia was agreeing not to push prices up much, if at all, with larger production cuts and supply disruption.

Iraq

In the months leading up to OPEC's "Vienna Agreement," Iraq's oil minister was quite blunt. Iraq's new oil minister, Jabar Ali al-Luaibi, had said, in effect, it is willing to play along but will not actually restrain production.

Iraqi Oil Minister Jabar Ali al-Luaibi. Iraqi News File Photo.

The ministry has new ambitious plans to develop the oil sector Among them, the most important is to increase crude output to reach a level that suits Iraq's needs; we don't want to specify a ceiling for future production like in the pastIraq is seeking to play an active role in order to support oil prices while preserving a share that is proportionate to its reserves."

Meanwhile, a senior government official close to Prime Minister Haider al-Abadi told Reuters:

OPEC must submit to the fact that Iraq must stay away from any possible output cut deal because the country is in the middle of a tough war and every single dollar is needed to keep it standing on its feet."

Falah al-Amri, Iraq's OPEC governor and head of the country's state marketer SOMO, was even more direct in saying that Iraq would not cut production, "Not for OPEC, not for anybody else."

Oil majors BP (NYSE:BP), Shell (NYSE:RDS.A) (NYSE:RDS.B) and Lukoil (OTCPK:LUKOY) have agreed to resume investments in oil fields the foreign groups are developing, which was expected to raise the country's crude output by 250,000-350,000 barrels per day in early 2017, Reuters reported. Iraq's oil minister Jabar Ali al-Luaibi pledged to work "day and night on increasing the national production of oil and gas."

According to the OPEC agreement, Iraq is required to cut 210,000 b/d from its October output levels, according to the table, for a quota of 4.351 million b/d. Iraq reported that its production averaged 4.6 million barrels a day over the first two months.

In a press statement issued on Thursday, Iraqi Ministry of Oil spokesman, Assem Jihad, said that the daily average national crude oil production in all oil fields in Iraq reached 4.665 million barrels per day. He confirmed that Iraq is committed to cutting national crude oil production in line with OPEC's agreement to support oil prices and take control over the abundance of oil supply in the global markets. With the agreement almost half over, Iraq is proving that it will comply verbally with the agreement, but it will not cut its production for OPEC.

Data on U.S. crude imports from Iraq show that it is picking up market share. Imports in the year-to-date are up 230% v. the same weeks in 2016.

In what may be a red herring, the Iraqi oil minister said the OPEC deal was based on exports and not production totals. "This time, for the first time, OPEC implied that production should be separate from export and their baseline is exports not production."

The agreement clearly states production, not exports. "All countries -- export," Luaibi said when asked whether only Iraq was required to reduce exports, not production, under the deal. "It's export."

He went on to state that production was on an upward trajectory, and by the end of this year "definitely we are going to reach the level of 5 million b/d." The latest addition to Iraq's production came from the Badra oil field, which is operated by Russia's Gazprom Neft. The company commissioned three new production wells earlier this month.

Iraq's long-term ambition is to double production to Saudi's level. Iraq recently awarded seven contracts to increase its production by over 4.7 million barrels per day (mmbd) in the years ahead. Lukoil, the largest oil firm in Russia, signed a deal to develop one of the world's largest untapped oil fields, the West Qurna-2 reservoir. Norway's Statoil (NYSE:STO) will share in the project. "We can announce that Lukoil has won the contract to develop the West Qurna-2 oilfield," Oil Minister Hussein al-Shahristani said. The projected output for the field is 1.8 mmbd.

The equally large Majnoon field was auctioned to Shell and Petronas (OTC:PNADF). In total, seven deals were signed in a two-day auction process.

Conclusions

Global inventories will not be much closer to their 5-year average by the May OPEC meeting. Therefore, I believe the Saudis will want to extend it for the full year.

However, with Iraq only complying verbally, it is questionable whether the Saudis will tolerate their non-compliance. They may "torture" them by increasing their own production. It will be a tough call for the Saudis to make if Iraq is effectively offsetting their production cut.

If Iraq does increase its production to 5 million barrels per day, instead of decreasing it by the 210,000 b/d it had agreed to, OPEC's production cut would be reduced by about 650,000 b/d, to about 500,000 b/d. And that cut could even be offset by rising production in Libya and Nigeria.

Finally, the non-OPEC production cut of about 400,000 b/d (less than the 600,000 b/d cut agreed upon) may be replaced with American shale production by the end of 2017. And it may happen more quickly than that because the Dakota Access Pipeline is expected to be "fully line-packed and ready to go" prior to 1 June.

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Link:
Saudi Arabia And Iraq On A Collision Course In OPEC Deal Extension - Seeking Alpha