Last Wednesday, Saudi Arabia finally pulled it off. The world’s largest oil exporter and de facto OPEC leader led the 14-nation oil producing cartel in its first oil production cut agreement since 2008.
Much has already been said about the deal since it was reached, while markets have reacted in jubilation. The following three trading sessions after the deal was reached to trim OPEC production levels by 1.2 million barrels per day (b/d) – more than 1% of global output – both global oil benchmark, London-traded Brent crude and its U.S. counterpart, NYMEX-traded West Texas Intermediate (WTI) crude had spiked by around 15% to levels not seen since mid-2015.
On Tuesday, markets did pull back some as traders engaged in profit-taking. Brent crude fell 0.1% to $54.93 a barrel while WTI futures were trading down 0.4% at $51.59 a barrel.
Doubt is also starting to surface, had to expect it, over OPEC’s ability to enforce its members to actually cut production per terms of the deal which is slated to start in January. OPEC members have a checkered history of compliance when it comes to oil production cuts.
Also, more work remains. Non-OPEC members, including Russia, the world’s largest oil producer who pumped 11.2 million b/d in November – a 30-year high, will meet with Saudi Arabia and other OPEC members on Saturday in Vienna to hash out an agreement.
Russia, Oman, Bahrain and Azerbaijan have already committed to attend the meeting, while Mexico and Kazakhstan will also likely show up, OPEC officials have said. It’s the first time in 15 years that Russia has pledged to join OPEC in an oil production cut.
Will Russia play the role of spoiler?
However, talk about a chance to play spoiler. If non-OPEC members, mostly Russia, fail to comply, it will minimize OPEC’s output deal and the corresponding market jubilation, effectively wiping out the past several days of gains. It will also signal that OPEC’s influence to sway markets in the mid to long-term has greatly diminished.
Will Russia comply? That depends on who you ask. Chris Weafer, senior partner at Macro-Advisory, told CNBC that Russia won’t comply with its side of the OPEC oil supply agreement to cut production by 300,000 b/d. He said that Russia could easily argue “technical issues” and not fulfill its part.
Even if Russia does come on-board, there are some definite problems for the Saudi’s (OPEC’s) desire to restore equilibrium to an oil market so awash in supply that it has been called by many the worst oil market crash in a generation.
Here are a few of the reasons:
First, the oil cut agreement is for a period of six months, then hast to be renewed again. That might not be a problem, but given OPEC’s history, it could pose a problem if various members reconsider their positions, particularly Iran and Iraq.
Second, the OPEC deal was based on October production numbers, when combined OPEC output was at a record high 33.54 million b/d., the fifth consecutive month of higher production. Moreover, though the Saudis agreed to cut production by 486,000 b/d, to 10.058 million b/d, it’s marginally lower than the 10.25 million b/d the country produced in January this year.
A quick look back at January reminds us of a market awash in supply with oil prices dipping into the $20s-range, industry layoffs and plenty of dismal developments – not much comfort there.
Basing their cuts at record high levels takes the term disingenuous to a new level.
Added to the fray is U.S. tight oil production. As much as the Saudis want Russia to come on-board, they must loathe even more those upstart U.S. shale oil producers that started the oil supply glut in the first place. Sure, Saudi Arabia’s two-year pump-at-all costs strategy drove many U.S. producers out of business – but U.S. shale oil was already posed for a comeback before OPEC reached its agreement with corresponding higher prices over the past week.
In September, Goldman Sachs forecasted that U.S. shale oil would increase by as much as 600,000 to 700,000 b/d by the end of 2017 – roughly equal to the amount that OPEC wants non-OPEC members to agree to cut – not much comfort there either even if Goldman’s forecast is overly optimistic.
The U.S. is the world’s third largest oil producer. Production for 2016 will average 8.9 million b/d, this is down from an average of 9.4 million b/d in 2015, the U.S. Energy Administration (EIA) said in its Short-Term Energy Outlook on Tuesday.
A day after OPEC’s oil output cut agreement global commodities data provider Platts said that analysts expected U.S. tight oil declines to start moderating if prices hold at $50/barrel and rebounding at $60/barrel.
Some are even calling the recent uptick in oil prices on the back of OPEC’s agreement, recovery hype. Even with a supply cut just over 1 million b/d, it will take 1.5 years for OECD oil inventory levels to stabilize – not much comfort there again.
While it’s too early to call OPEC’s output deal a bust, particularly since Russia and other non-OPEC members might get on-board, it’s also fair to claim that given the factors just discussed, the OPEC output cut agreement simply isn’t enough . The best it might do is create an upward trend for prices in the short-term, possibly until its time to renegotiate the deal again in six months and hopefully establish a much-needed price floor in the low $40s.