Russia Has Your Back, OPEC. What Could Go Wrong?

(Bloomberg Opinion) -- The only country that could really make OPEC+ work is the U.S. That’s not an option, so it’s stuck with Russia. OPEC’s own forecasts show just how much sway Moscow has over the group.

Next year looks ugly for oil producers. OPEC expects demand to grow by 1.14 million barrels a day, flat with expectations for this year (which have been coming down). But it also expects supply from non-OPEC countries to surge by 2.4 million barrels a day. Hence, the world will need fewer OPEC barrels: 1.34 million a day, equivalent to almost the entire production of Angola.

And OPEC’s market share has been dropping already. The International Energy Agency piled on Friday morning with its own monthly report, surmising implied demand for crude oil from OPEC could drop to 28 million barrels a day in early 2020, an amount the group last produced in summer 2003.

The bugbear, as ever, is U.S. shale production. America accounts for 71% of that extra non-OPEC supply forecast for 2020. Brazil and Norway are also big contributors, albeit way behind. The 10 partner countries that form the “plus” bit of OPEC+, meanwhile, account for 5%.

That small increase for the “plus-ones,” so to speak, is interesting. Virtually all of it stems from an expected uptick in Russian production penciled in beyond the first quarter of 2020. That is when the current phase of the OPEC+ supply cuts are scheduled to end, so OPEC’s forecasters are assuming Russian output, along with some other countries’, ticks up again.

It’s a revealing assumption because it also rests on the assumption that Russia’s compliance with cuts – a relatively recent phenomenon – will actually intensify this year to levels never achieved before.

The IEA’s own projections display a similar faith in Russian restraint, implying compliance of almost 240%. The lingering effects of this year’s problems with contaminated oil have served to bolster Russian compliance, mathematically at least. And President Vladimir Putin made a big show of cutting (and announcing) his deal with Saudi Arabia to keep supplies curbed.

Yet it must be unnerving for Saudi Arabia to depend this much on the discipline of a major rival oil producer not exactly known for such discipline. Indeed, the whole premise of the “plus-ones” is somewhat Potemkinesque when you take a closer look. Six of the 10 countries barely count at all, each tasked with reducing supply by 20,000 barrels a day or less – drops in a vast, oily ocean. Even then, they aren’t expected to collectively meet their obligations anyway. Oman contributes a little more, but the positive aspects of the plus-ones for OPEC really boil down to just three countries. 

Kazakhstan’s enormous contribution, particularly in 2019, is a function of maintenance being performed on two giant oil fields rather than a strong sense of commitment (judging by its track record over the past two years, anyway). Similarly, Mexico’s projected compliance of almost 400% across the period is mere impotence dressed up as abstinence. Involuntary or not, one less barrel is one less barrel. Still, depending on others’ misfortunes is a defining, and telling, characteristic of OPEC+. At a more extreme level, Venezuela fulfilled a similar function in the first phase of the cuts, and it remains reliably unreliable.

Russian discipline is, therefore, crucial to maintaining the illusion of control. Say, instead, the country adhered to its average compliance level since January 2017 of 57%. Relative to OPEC's current projections, this would add back roughly 100 million barrels to the market through the end of 2020. That is a huge amount when you consider Khalid Al-Falih, Saudi Arabia’s energy minister, recently floated the idea of trying to slash global oil inventories by more than 200 million barrels.

Above all, these cuts, both real and conjectured, are happening in the context of weakening demand prospects. Growth in oil consumption in the first quarter slumped to its lowest level since 2011, according to the IEA’s latest report. The agency still forecasts a rebound in the second half of 2019, which looks ever more curious in the face of weakening expectations from the likes of OPEC and a steady drip of bad economic data, the latest coming from Singapore and China, the heartland of oil-demand growth. Consider this: Tropical Storm Barry has forced a million barrels a day of supply offline in the Gulf of Mexico; and, yes, oil prices have rallied a bit but remain below where they were just two months ago.

Cutting oil supply to support prices in a fundamentally weak market is a Sisyphean task, which is why the OPEC+ agreement, originally penciled in for six months, is racing toward its third birthday. Signs of strain are building in the U.S. shale business model, but OPEC has been waiting in vain for a Texan collapse for years (plus, its own actions provide breathing space for even the most overextended wildcatter). In the meantime, it relies on actual Saudi discipline, a motley crew of walking wounded, and – crucially – faith in Moscow’s fidelity. What could possibly go wrong?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

©2019 Bloomberg L.P.