A man holds a pool of black oil in the palm of his hands, collected from oil pollution caused by a damaged pumping station in Nigeria. (Photographer: George Osodi/Bloomberg)

As Oil Stocks Drain, OPEC Searches for Its Next Fig Leaf

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(Bloomberg Gadfly) -- There is no doubt that the output cuts made by OPEC and its friends, aided by a collapse in production from group member and historic quota cheat Venezuela, have drained a lot of excess oil out of the supply chain. Tankers floating full of crude off the coasts of Iran and South Africa have disappeared and total U.S. stockpiles are close to their lowest in almost three years.

But now their goal is within sight, or it may already have been passed. And that creates problems for the producer group.

If inventories are back where they say they want them, but prices haven't recovered as much as they would like, they need to find a way to justify prolonging the cuts to boost their revenues.

Since November 2016, OPEC has been able to get away with the idea of trying to return oil inventories to a five-year average level. That seems a very clear and precise target, but, as I wrote last month, it isn't. And at this point, it's no longer possible to maintain the charade.

The Joint Ministerial Monitoring Committee set up to oversee the OPEC+ output deal will discuss the inventory target when it meets in Saudi Arabia in April. My Bloomberg News colleague Grant Smith has written a very clear explanation of how they might shift the inventory goalposts. The trouble is, that some of the tweaks they might look at could end up indicating they have already overshot their target. 

Inventories can be measured in many different ways: the simple volume of oil in storage, the number of days of demand that volume could meet, or, like the International Energy Agency's emergency stock-holding obligations, the number of days of imports they could cover.

The choice of the period over which to average "normal" inventory levels will also have a big impact on determining when the target has been reached.

Comments made by oil ministers of Saudi Arabia and Russia last week suggest that the group and friends will land on a clarification of their oil inventory goal. But a less-widely reported comment by Khalid Al-Falih suggests that the target may shift away from just focusing on inventory levels.

Finding reliable data for inventories remains a challenge, Al-Falih told reporters in Riyadh on Feb. 14. Fixing on a period of "normal" inventory levels to target, or measuring in terms of days of cover, won't solve that problem. 

OPEC's real problem is not whether to measure in days or in barrels, but whether it can ever adequately count inventories outside the developed countries of the OECD. And it is arguably these other countries that really matter. They already use over half the oil consumed worldwide and are expected to account for 80% of demand growth this year.

But Al-Falih also said that looking at inventories alone isn't sufficient to assess market balance.

Could this presage a shift in the group's target away from one based on inventories? Perhaps not immediately, but it does suggest that, as inventory data show the job maybe nearly done, producers could be starting to look for another fig leaf to justify extending the deal. That could be as simple as targeting an earlier five-year average.

But what really matters to the group is the revenue they generate from producing and selling the black stuff. Pursuing an overt revenue target, or its close cousin, a price target, is probably not feasible. Not only would it open them up to accusations of acting as a cartel, but each of the 24 members of the expanded OPEC+ group has different revenue needs and a different break-even price.

The group has been very successful in boosting oil prices since the middle of last year, and as they have risen, so have producers' assessments of the "right" level. When OPEC and friends met last May, several ministers were talking quite casually about $50 a barrel as a good price for crude. No longer. Traditional price hawk Iran now finds itself at the dove-ish end of the spectrum, with oil minister Bijan Zanganeh seeing $60 as a "good" price for oil. Others have more ambitious targets.

Setting a clear price target is unlikely, but don't expect OPEC and friends to rush to open the production taps, even if inventory levels suggests they should. They are not yet making as much as they want from their oil and will now embark on a process of finding another metric that will tell them that the time is not yet right to boost supply.

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

Julian Lee is an oil strategist for Bloomberg. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

©2018 Bloomberg L.P.

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