There had been a debate as to whether the rollover should last six or nine months. The decision to go for nine months was wise and clearly needed when looking at the market reaction. The wisdom lies in giving markets some certainty beyond the next OPEC meeting, which will take place in December.
The price drop between Monday and Wednesday morning was about 6.3 percent. Some of this can be explained by the time-old tradition of buying on the rumor and selling on the news. It had been pretty clear that the production cuts would be rolled over after Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman had agreed to do so on the margins of the G20 summit.
On Monday markets were also temporarily euphoric about the trade truce that Chinese President Xi Jinping and his US counterpart Donald Trump had reached during the G20 summit. Weak Purchasing Managers Index numbers out of China and another set of soft economic indicators from Germany dampened spirits as the day went on. Reality also set in, because the understanding between Trump and Xi was a truce, not an agreement. There could still be many bumps on the road going forward.
There also remains uncertainty as to what will happen on the trade front with Europe, as well as if and when the US Mexico Canada Agreement (USMCA) will finally be signed. Europe is concerned about the impact a trade spat with the US would have on its automotive industry. Cars still constitute an important component of oil demand.
The market got what was expected from the meeting. The question was always whether 1.2 million bpd of production cuts would be sufficient. If we are to believe the forecasts of the International Energy Agency (IEA), markets will be hit by an incremental 2.3 million bpd of non-OPEC supply in 2020 and demand may be sluggish. The IEA predicts that next year the call on OPEC crude will be 600,000 bpd below current OPEC production at a time of OPEC+ overcompliance, aided by Iran sanctions and the continuous woes of the Venezuelan economy.
OPEC+ also managed to agree on the framework to create a charter formalising their alliance under the Agreement of Cooperation. This is a significant step. Ever since the 24 nations started working together it was this framework that helped stabilize the markets and ease the peaks and trophy in oil price volatility. Whenever there was a glut and inventories became too high, OPEC+ enacted production cuts. Whenever markets became too tight, OPEC+ released some of its spare capacity. Ahead of every meeting though, markets were uncertain whether the cooperation would hold. Before every OPEC+ gathering news outlets were afloat with rumors that some countries, especially Russia, would cease to cooperate. A charter will put some of these rumors to rest.
The most significant news from the meeting went largely unnoticed. OPEC+ and its Joint Ministerial Monitoring Committee (JMMC) use OECD oil stocks as the underlying metric informing their decisions. In 2016 they decided on the five-year average of OECD stocks as the benchmark. This was changed to the average between 2010 and 2014, reflecting the huge impact increased US shale production had on this metric. It was a clear signal to the market as to just how serious OPEC+ is about its role in balancing the markets.
All in all, the surprises coming out of the meeting were few and the markets had largely priced in the cuts going into the meeting. There were criticisms that OPEC was dead, because OPEC+ was basically run by the leaders of Saudi Arabia and Russia. Conversely, one can argue that having the top level of the two largest producers endorse decisions shows that these governments are dedicated and on board, which in turn is beneficial for the rest of the participants.
OPEC has been proclaimed dead many times in its nearly 60-year history. However, if we look at the price action over the past two and a half years, it was precisely OPEC+ that managed to curtail extreme volatility. Less volatility is helpful, because it provides an environment allowing producers to allocate investments and consumers to forecast their costs more accurately.