Since the last OPEC meeting in December, Brent prices have risen from $61 to $74 led by the front of the curve. Global inventories have continued to fall due to strong demand and continued supply restraint. Incredible supply growth in the US has been tempered by transport bottlenecks which have cheapened oil prices in the US relative to world prices. Regardless, US exports have grown while output has declined rapidly in Venezuela, where political instability has caused the oil industry to contract. Partly as a result of this contraction, OPEC now has more leverage in price setting than in recent years. Country specific quotas have been met with strong compliance by member nations while ex-OPEC countries like Russia have cooperated as well. OPEC has seemingly preferred for oil prices to rise rather than to make up for sharp declines in Venezuela production. In fact, current OPEC policy has resulted in restraining 1.9mm barrels per day (bpd) from the market where the agreement mandated a cut of only 1.2mm bpd. This over-compliance could intensify later this year as renewed US sanctions are scheduled to remove Iranian barrels from the market, further limiting OPEC output. In May, market expectations around sanctions helped to push Brent prices to $80. OPEC’s drive to higher prices has been motivated by domestic factors but has hit a road block due to mounting criticism from consumer nations and particularly President Trump.
With this as the backdrop, OPEC and non-OPEC producers met last week to ratify an increase of oil production. The result was a commitment to end over-compliance by increasing production in line with the original agreement. This was the main passage from Friday’s OPEC statement: “countries will strive to adhere to the overall conformity level of OPEC-12, down to 100%, as of 1 July 2018 for the remaining duration of the above mentioned resolution”. The logical conclusion of this statement is that Saudi Arabia, which controls most of OPEC’s spare oil production capacity, must produce more than its quota. This reflects a change in policy, scrapping the country specific quotas in exchange for greater control by Saudi Arabia and key allies. In effect, Saudi Arabia is re-assuming its role as global swing producer for crude oil (at least over the next 18 months while US export infrastructure is put in place). Russia’s cooperation and partnership with OPEC is also notable as the country’s footprint grows on the global stage. Russian producers have invested in additional capacity and could help to bridge the production gap over the coming year. Both themes were evident during the weekend press conference where Saudi Energy Minister Khalid al Falih, seated next to the Russian oil minister, said: “We will do whatever is necessary to keep the market in balance”.
The OPEC meeting outcome suggests that Saudi Arabia will seek prices which are high enough to pursue domestic objectives while demonstrating care for consuming nations. Taking this into account, our price forecast on Brent crude is $75 for Q3 and $70-80 through year end. Because the supply/demand balance remains tight and Saudi Arabia’s spare capacity is finite, we place somewhat higher probability on a breakout to the higher side for oil prices than the lower side this year. This would likely come from a renewed upturn in global growth and/or prolonged production outages which are increasingly important in this environment. Demand is the largest downside risk for oil prices this year. Slowing demand would put stress on OPEC supply discipline. Ultimately the next recession may cause the agreement to fall apart all together and the move away from country quotas contributes to this future risk. Rising US supply is also a bearish price risk, but bottlenecking is likely to remain an impediment until well into 2019 or 2020. Another risk to consider is how the US responds to the meeting outcome.
In conclusion, oil markets are returning to a familiar place where Saudi policy is the strongest influence on price. We will focus on their communication and geopolitical intentions as the global swing producer.
 Italics added for emphasis