If there’s one conclusion to be drawn from oil’s return to $70 a barrel, it’s that OPEC has learned from its mistakes.
Crude’s rally to a four-month high has largely been driven by production cuts by the Organization of Petroleum Exporting Countries and its partners, a coalition that pumps about half of the world’s oil. It’s a strategy they previously deployed in 2017 -- but whereas that effort initially struggled, this time the impact has been almost immediate.
The alliance’s greater success reflects how its de-facto leader, Saudi Arabia, has learned from errors made two years ago. The kingdom has honed its implementation -- making the cutbacks more proactive, deeper, and focusing them specifically on the market that matters most.
“They’ve executed this pretty flawlessly,” said Helima Croft, chief commodities strategist at RBC Capital Markets LLC in New York. “The message has been consistent, the action has been resolute.”
By cutting supply, OPEC and its allies prevented the re-emergence of a surplus due to booming U.S. shale output and a slowing global economy. As a result, oil prices climbed 27 percent in London in the first quarter, their strongest in almost a decade. At about $70 a barrel, crude is approaching the levels the Saudis and other OPEC members need to cover government spending.
Admittedly, oil’s surge has much to with unintended OPEC actions, as exports from member nations Venezuela and Iran are squeezed by political and economic crises. But as the Saudis continue to restrict supplies even as losses mount elsewhere, the paramount driver appears to be Riyadh’s determination.
“I don’t think luck has anything to do with it,” said Mike Wittner, head of oil market research at Societe Generale SA. “The Saudis have been very aggressive in their supply management. Very determined, and also very transparent.”
OPEC first forged its partnership with non-members such as Russia and Kazakhstan, the 24-nation coalition now called OPEC+, in late 2016. But in the final weeks of that year, the largest producers ramped up oil production to maximize sales before their pact to constrain supplies took effect. As a result, inventories continued to swell and prices declined 16 percent in the first half of 2017 even as output cuts were implemented.
“If there was any error, it was the big surge in output back in late 2016, which put them on the back foot,” said Wittner.
This time, however, Saudi Arabia has shown more discipline, slashing output by the most in two years in December -- before the new OPEC+ accord took effect. The kingdom has also doubled-down on its readiness to make even bigger supply cuts than promised, pumping at a four-year low of 9.82 million barrels a day in March.
Those curbs have been focused on the biggest and most transparent market place, the U.S., and Saudi Energy Minister Khalid Al-Falih has also become more direct in advertising his plans.
In 2017, the Saudis maintained exports to the U.S. at elevated levels for the first five months of the initiative. This year, the kingdom promptly squeezed flows to America, cutting them to just 346,000 barrels a day during one week in late February, the lowest in government data going back to 2010.
“It’s a lesson learned from 2017,” said Mohammad Darwazah, a director at Medley Global Advisers in New York. “It’s also the most visible and market-moving data point.”
Back then, OPEC initially missed its stated goal of returning oil inventories to average levels. In the first three months of 2017, as the extra shipments by the Saudis and others at the end of the previous year hit the market, U.S. crude inventories ballooned by almost 57 million barrels, or about 12 percent, according to the Energy Information Administration.
This time around the cuts hit their target right away. U.S. stockpiles have shrunk from being about 34 million barrels above their five-year average at the beginning of this year, to now stand in line with it. Admittedly, a portion of that reduction has been caused by record American exports as the shale boom turns the U.S. into a global oil supplier -- a sign that OPEC’s success comes at a price.
The cartel’s reward for improving the execution of its cuts is Brent crude at $70 a barrel, 28 percent higher than it was at this juncture in 2017. Yet this success also creates political dangers.
U.S. President Donald Trump has resumed his attacks on the cartel for propping up prices, and could allow the passage of antitrust legislation that would target the financial assets of OPEC members.
But defying Trump, at least for now, appears to be another lesson Riyadh has learned from the recent past. The kingdom flooded oil markets last year after the White House promised to choke off Iranian crude exports, yet the pledge went unfulfilled. Saudi Arabia now has to demonstrate independence from Washington, RBC’s Croft said.
Al-Falih repeated in Riyadh on April 8 -- less than two weeks after Trump again called on OPEC to boost production -- that his priority is still to “bring inventories down.”
“The Saudis had a credibility gap after what happened with that production surge -- people thought Trump could call the shots,” said Croft. “The Saudis have had to work doubly hard to signal the market that they’re in it to win it. That’s what’s paying off for them.”
© 2019 Bloomberg L.P