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The OPEC deal could be collapsed in 2018

Published On Dec. 26, 2017 By Madhuri

Oil market is kept on track by the OPEC. Extension to balancing at some point next year, deal could collapse, if the group overshoots on tightening which could result into beginning of OPEC members cheating. To be sure, there is a great deal of uncertainty over the pace of inventory draw downs. The IEA (International Energy Agency) predicts a return to rising inventories in the first half of 2018, a prospect that threatens another downturn in prices. Downside risk is much more threat than the upside, said some analysts and oil market should brace for lower prices.

October's 5 year average for the inventory surplus has dramatically narrowed this year, falling to just a little more than 100 mn barrels above, down more than two-thirds from the start of 2017. That obscures the fact that the draw downs really kicked into high gear only in the second half of this year, a rapid drawdown that coincided with a sharp up-tick in prices. OPEC compliance hit its highest point in November, which should continue to put pressure on stocks in the next few months.

Analyst Goldman Sachs argues that the inventory increases in the 1st quarter of 2018, will be much smaller than the typical gains for that time of year, with stocks once again drawing down by the 2nd quarter. Goldman added in his report that the oil market will "rebalance" by mid 2018, before adding this intriguing prediction: leading to a gradual exit from the cuts and increases in OPEC and Russia production through 2018. OPEC will have completed its mission or at least will be close at about the time it meets again in Vienna in June. Thereafter, with oil prices rising and the inventory surplus eliminated the justification for OPEC’s production cuts will lose their urgency, and members will be tempted to cheat.

According to head of commodity strategy at Saxo Bank, Mr. Ole Hansen, higher oil prices would be an open invitation to cheat, before we get there and this could lead to a collapse of the deal. Russia expressed an eagerness to exit the deal as soon as the market surplus is eliminated and Russian officials voiced some scepticism in the lead-up to most recent extension.

As oil prices grow, alongside impetus to cheat will grow, because of some reasons that includes

1) Higher prices will prove to be tempting, because each additional barrel will bring in even more revenue.

2) At some point in 2018, as inventories fall and prices rise, OPEC members will know that the expiration of the deal will not be far off, so why not get a head start on a return to higher production levels?

3) OPEC members know that higher oil prices are a real danger to their market share because it could provoke an aggressive response from U.S. shale drillers.

Earlier this month, Brent rose to $65 per barrel, one of the OPEC officials expressed concern and told that you are attracting problems for yourself' with oil up in the mid-$60s. OPEC fears, this could result into U.S. shale will add a wave of new supply. “If prices are attractive for other producers, we will be going back to square one,” the official said.

A tricky balancing act is the problem for OPEC, and it isn't clear that there is a price window that will satisfy the need of OPEC members while also proving to be low enough to stave off new shale investment.