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OPEC, Feds in fog of uncertainty

What do OPEC and the Federal Reserve have in common, other than being on the receiving end of angry tweets from President Donald Trump?

They are both having a particularly terrible time assessing the outlook for demand, and this is making setting policy exceptionally fraught.

The Fed must adjust interest rates and other policy levers to achieve its twin goals of low and stable inflation and full employment. In the case of OPEC nations and their band of friends, ministers have to judge the production needed to balance global supply and demand. At the current juncture, this means deciding whether to continue restraints on output set at the start of 2017 – their current deal to cap supply ends in three months.

Faced with such uncertainty, the committee overseeing the OPEC+ reductions suggested last week that the group should abandon a planned April meeting where they could have decided whether to extend the deal. Instead, officials gathered in the Azerbaijani capital of Baku said that a decision should be delayed until June.

The Fed perhaps envies such flexibility. Both institutions are confronted by a murky economic outlook, but at least OPEC can get away with deciding not to meet. Though there may be greater clarity on U.S. trade deals with China by the end of the second quarter, Europe took a turn for the worse last week with the publication of data showing weakness across France and Germany. That bodes poorly for both global economic growth and oil demand, and complicates the decision making for both the Fed and OPEC+.

But for OPEC+, prospects are also difficult to divine on the supply side. It’s hard to get a read yet on the impact from Russia’s promised output cuts, as officials said they would implement these only gradually over the first quarter of the year. By February they had only made 35% of their promised reduction, based on production data from the Russian Ministry of Energy.

Similarly, the effect of the latest round of Middle East cuts is only just starting to show up in import data, as it takes around six weeks for tankers leaving the Persian Gulf to reach the U.S.

Then there is the fog of uncertainty swirling around production levels in the Shaky Six.

In Venezuela, the remaining support for President Nicolas Maduro shows little sign of collapsing, while oil production continues to slide. That could mean that the rest of the OPEC+ group must produce more to offset the drop.

One thing we will know more about by June is the fate of the current waivers granted to eight buyers of Iranian crude, which expire in early May. The Trump administration may attempt to create the illusion of getting much tougher on the country by cancelling waivers that Greece, Italy and Taiwan had been given to buy Iran’s oil, but have never exercised. Even if the U.S. were to extend waivers that had been given to five other countries, and perhaps throw in some token volume reductions, this would actually reduce the physical flow Iran’s oil only marginally. What we still won’t know, though, is the willingness of buyers to continue taking Iranian oil.

The main oil forecasting agencies have yet to cut their oil demand forecasts significantly, but they may soon have to. They tend to be very reluctant to make big changes, so the means that they have often lagged more nimble analysts when big shifts happen.

We often feel more confident in our forecasts the closer we get to the period they cover – and so we should. But just take a look at the historical revisions made to oil supply and demand numbers, sometimes going back several years, and you quickly see that that clarity is often an illusion.

So, while a strong case can be made for delaying an OPEC+ decision on the second half of the year, there were good reasons for holding the meeting as planned, too.

For most of the noughties OPEC held its regular meetings in March and September, setting production policy for the half years beginning the following July and January, respectively. While there is obviously greater uncertainty in trying to forecast further ahead, there are practical advantages in building in a delay.

It takes time to turn a decision into action. Customers have to request – or nominate, in industry jargon – how much oil they want to buy from suppliers more than a month ahead of loading it onto tankers. The sellers then tell them how much they can have. Saudi Aramco decided its allocations to would-be buyers for April shipments two weeks ago.

Holding the meetings in June and December, as OPEC began to do in 2011 after months of wrangling over whether to increase output targets that had been in place since the start of 2009, leaves no time to implement those decisions the following month. This is part of the reason why the initial implementation of output cuts has been so poor.

There had been some surprise back in December when the ministers announced that they would be meeting as soon as April to decide whether they needed to extend the arrangement through the second half of 2019. That seemed ambitious scheduling, particularly as they planned to meet again in June anyway. Holding two meetings in such quick succession always looked excessive.

Their U-turn means the oil producers in Baku have sacrificed the ability to implement any new deal in July for the illusion of clarity on what will be required from them. The market outlook will be just as uncertain in June as it is now, even if some of the uncertainties have changed. Making a decision in April would have sent a clear message of intent and dampened speculation. Leaving it to the last second simply creates uncertainty and injects volatility into prices – as the Brits, with Brexit coming down to the wire, know only too well.
Source: Bloomberg

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