Oil Supply Balances: The Four Cycles of the OPEC Oil Output Policy
OPEC exit strategy has been one of the key uncertainties engulfing the oil market. Most market focus has been on the level of inventories, as this is seen by many as a key indicator as to when OPEC may shift its current output policy. In this presentation, it is argued that the level of inventories, however measured, is a backward looking indicator, and hence is of little use for guiding OPEC’s next steps. Instead, through thorough analysis of the previous cycles we show that in the presence of a new source of supply, which is highly responsive to price signals, demand related shocks become much more important in shaping OPEC behaviour. The high output strategy adopted in 2015 was undermined by a negative demand shock. The current strategy of cutting output has succeeded in large part due to a strong positive demand shock, which caused inventories to continue to decline despite strong US shale response. Thus, the risks of potential ‘trade wars’ and the potential negative impact on the global economy and on oil demand if these risks do materialise should constitute a serious concern for OPEC. OPEC’s current strategy hinges heavily on the prospects of future demand growth. If demand continues to surprise on the upside (positive demand shock), then OPEC will most likely maintain its strategy and may decide to release some of the withheld crude back to the market. If demand surprises on the downside (negative demand shock), then OPEC’s choices become very stark: OPEC could either decide to cut output to support prices or shift toward a higher output strategy. Both choices carry hefty risks reflecting the delicate situation that OPEC finds itself in as a result of the shift in policy back in November 2016.