When OPEC signed their historic deal to cut member production by a collective 1.2 million barrels a day, the oil industry celebrated. Investment would once again rise, the glut of oil in land and floating storage which was reaching full capacity would shrink and prices would start a steady climb upwards. Two months on and the market is beginning to question how successful the OPEC play has been.
Should traders equip themselves legally for a renewed rush to storage? Will there be a renewed Contango with its storage arbitrage? We look at what in-house counsel can do to prepare for what could be a 12 month rollercoaster ride.
Scenario 1: The OPEC Plan succeeds
Let us assume that OPEC's plan comes to fruition. We should start to see a period of rising but steadying price movement. The Contango will dry up and storage capacity will become available as production limits start to have effect. We describe below the likely legal issues that would arise as a result.
- Traders who have bought into long term storage agreements may need to downsize. This could lead to penalties for premature termination, depending on the terms originally negotiated
- An uptick in pricing may put some buyers with long term supply contracts under pressure. It will be important to consider whether credit risk mitigation and guarantee cover is adequate
- A pricing shift is likely to affect prepayment long term supply deals. In particular, balancing payments will increase.
Scenario 2: Production over heats and prices become volatile
There are of course elements of the market which OPEC cannot control. Russia sits outside of OPEC and the production strategy of US shale producers has at times defied economic logic. Will Iran stick to the game plan given their recent return to the market? With these factors combined, there is certainly no guarantee the OPEC plan will succeed. But what will happen if we return to the boom/bust era? We describe below some of the ramifications.
- Contango could return and storage capacity would be at a premium once more. Flexibility of storage arrangements will be required
- Banks may get nervous about financing in an uncertain market making finance availability scarce
- Volatility will inevitably bring casualties. Credit exposures will need to be checked
What can Counsel do to protect themselves?
- Review storage contracts for termination/extension/redelivery provisions
- Assess time available operationally and put increased financing in place to cover increased pricing for same volumes
- Examine impact on long term supply deals – will your credit/guarantee arrangements be adequate?