LONDON (Reuters) - (John Kemp is a Reuters market analyst. The views expressed are his own)
Ministers from the Organization of the Petroleum Exporting Countries and their allies meeting in Vienna on Thursday must make a series of fairly straightforward decisions but weigh the risks carefully.
Ministers must consider six basic dimensions: (1) whether to extend or not; (2) whether to adjust production levels; (3) whether to include additional countries; (4) the duration of any extension; (5) whether to make an extension conditional on a further review of market conditions; and (6) exit strategy.
The most basic decision is whether to prolong the production pact between OPEC and non-OPEC countries set out in the Declaration of Cooperation in December 2016 and extended in May 2017.
If the pact is extended again, and there appears to be consensus on this point, the question is whether to adjust the production levels, how long any extension should be, and whether it should be conditional.
In theory, ministers could deepen or reduce existing cuts, but there appears to be a consensus on keeping them at current levels, although the agreement could be modified to bring Nigeria and Libya within the framework.
The principal remaining questions are therefore how long the extension should be, whether it should be conditional on some form of review of market conditions, and whether to agree on an exit strategy now or later.
The current agreement is scheduled to expire at the end of March while the next OPEC meeting will not occur until May or June 2018.
A three-month extension to the end of June would re-align a decision with the cycle of regular OPEC meetings but risk disappointing investors who appear to be betting on a nine-month extension to the end of 2018.
OPEC and non-OPEC officials have encouraged expectations of a longer extension and fund managers hold a near-record bullish position in futures and options so a shorter extension risks sparking a sharp fall in prices.
A nine-month extension to the end of December would also re-align the decision-making with the regular cycle of OPEC meetings while validating hedge fund expectations and ensuring market sentiment remains positive.
The main problem with a nine-month extension (which is really a 12-month extension from now) is that market conditions could change significantly between now and the end of 2018.
With oil consumption growing rapidly, the oil market in deficit and inventories falling, a 12-month extension risks causing the market to tighten too much, sparking a spike in prices and a resurgence of shale drilling.
Ministers may therefore want to make the extension conditional on some sort of interim review of market conditions.
OPEC’s next scheduled meeting in May or June 2018 will provide an opportunity to take stock of market conditions and adjust the depth and duration of production cuts as well as plan an exit strategy.
The critical question is whether ministers make this interim review explicit in any extension decision or leave it implicit.
An explicit review would reassure analysts worried about the market tightening too much but risk making the organization’s resolve seem weaker.
Leaving the review implicit would send a strong and aggressive signal to the market but intensify concerns about whether OPEC risks tightening too much.
The final set of questions surrounds an exit strategy. Ministers could signal this now or leave work on the issue until the next meetings in May/June or even November/December 2018.
In practice, the exit period is some way off, so ministers may decide it is more prudent to leave the decisions until nearer the time when market conditions can be assessed.
The exit strategy, when it comes, could involve negotiating a fresh Declaration of Cooperation, with new and revised production limits among the existing group, or a smaller group.
But it could also revert to separate decision making by OPEC members, recognizing that the pact with non-OPEC countries was a temporary emergency measure.
And if negotiating revised production limits proves hard, OPEC could rely on diminishing compliance with the existing limits to increase the supply of oil to the market informally without formal action.
Ministers have lots of options but the basic strategy seems reasonably clear. The critical questions are mostly about how to present it to reassure bullish investors while calming fears of a price spike.
“Hedge funds lighten bullish positions”, Reuters, Nov. 28
“OPEC’s options for extending production pact”, Reuters, Oct. 26
“OPEC must think about exit strategy”, Reuters, Oct. 25
Editing by David Evans