(Bloomberg) -- OPEC and Russia have surprised the industry with the success of their grand alliance as oil surges to a three-year high. As the unlikely bond enters a second year, there are challenges ahead.
Here are four scenarios that could end their deal earlier than planned.
Street Fighting
Tension is flaring in OPEC members Iran and Venezuela, the two countries that RBC Capital Markets LLC says pose the biggest risk of supply disruption. If either nation shuts oil output as a result, fellow producers could just decide the restraints are no longer appropriate, and instead boost supplies to prevent a damaging price shock.
Discontent with economic stagnation has sparked the biggest street protests since 2009 in Iran, rekindling memories of the 1979 revolution that paralyzed crude production. To top it, U.S. President Donald Trump is threatening to pull out of a nuclear accord that helps OPEC’s third-biggest producer trade with other nations.
In Venezuela, food shortages and rampant inflation have threatened to trigger a massive social collapse. Even if the country can avoid that, the industry has already been hit so hard that production could slump anyway.
Mission Accomplished
Russian President Vladimir Putin could heed pressure from his country’s biggest oil companies for a swift exit. Though he gave his blessings to extending the deal, Rosneft PJSC and Lukoil PJSC have warned that if the measures drag on too long they could lose market share to rivals. With oil prices rising and stockpiles draining, Russia could persuade other countries to end the deal before its time.
To keep the Russians happy, OPEC has agreed to review the agreement at their next meeting in June.
“What happens in the second half is interesting,” Amrita Sen, chief oil analyst at Energy Aspects Ltd., said in a Bloomberg Television interview. “Do they continue with the cuts? Do they slowly raise production? Because the market is tightening, and it’s tightening very quickly.”
Temptation to Cheat
OPEC’s biggest weakness is “we tend to cheat,” former Saudi Oil Minister Ali Al-Naimi famously observed.
Last year, Iraq -- which initially resisted output curbs as it recovered from years of war -- was so slow to deliver on promised cuts that its petroleum minister was summoned to Riyadh. The country’s very public ambitions to expand capacity as soon as possible only add to doubt about its commitment.
“As seasonal demand picks up in the summer months, we expect Iraq’s compliance with the agreement to slip,” said analysts at BMI Research.
Though OPEC has produced less than the promised levels in the past few months, Libya and Nigeria remain the wildcards. Being initially exempt from the agreement, they boosted output at such a pace last year that the other countries enforced a limit on them as well.
Yet Libya’s production remains far below its theoretical cap. With the economy still ravaged by years of internal conflict, consultants Wood Mackenzie and Eurasia Group expect the country will pump every barrel it can.
Too Much of a Good Thing
The OPEC-Russia strategy has always contained a contradiction: by boosting oil prices, they risk triggering a fresh surge of output from the original source of the glut -- U.S. shale.
Crude in New York has increased to a three-year high, topping $60 a barrel, a level often cited by the shale industry as profitable for new drilling.
If the U.S. opens up more shale taps, Commerzbank AG (DE:CBKG) says OPEC and Russia’s logical response will be to abandon their strategy and return to the days of pump-all-you-can. The unlikely bromance could turn out to be a victim of its own success.
