OPEC’s output cuts are not a done deal

Robert Sierra - 8th December 2016

The recent OPEC deal lifted oil prices towards US$55pb and emboldened analysts into revising their forecasts for next year towards the US$60bp mark. The detail of the OPEC agreement provides for   crude oil output reduction of 1.2 million barrels a day during the first half of 2017 with non-OPEC members chipping in with a further 600,000 bpd cut. The bulk of the output sacrifice, around 40 per cent or 486,000 bpd, will come from Saudi Arabia, Iraq will provide a further decrease of 210,000 bpd and the United Arab Emirates contribute an additional 139,000 while Iran will be allowed to increase its output by 90,000bpd resulting in a combined OPEC daily production of around 32.5m barrels per day (see table below).

The success of the deal will depend on several factors including the participation of non-member countries, the cartel’s own chequered history of cheating on such agreements and the ability of US shale drillers to quickly ramp up production as prices rise. Importantly, Russia will need to keep its promises rather than renege as it has in the past. During the six months that the deal will last, observers will monitor oil tanker traffic to ascertain whether fewer ships are leaving port. But monitoring Russia’s contribution to the cuts will be difficult to observe since much of its production moves by pipeline. Russian shipments can also take circuitous routes to market, with ship-to-ship transfers off Cyprus and Malta. Moreover, Russia’s oil production is largely comprised of many wells pumping relatively small amounts of oil such that reducing output by the 300,000bpd they have promised would require shutting down over 4,000 wells; the cost of doing so would outweigh any potential benefits from higher prices.

But before the deal was even sealed, countries were already rushing to the pumps. A survey by Reuters gauging OPEC production for November estimates that 34.19mn bpd was churned out while Bloomberg puts the figure at 34.16mn bpd, with increases from Angola, Libya and Nigeria. It also surfaced last week that Russia’s total output had reached a new post-Soviet record of over 11.23m bpd in November. It is from this elevated production level that Russia will take off the agreed 300,000 bpd. In addition, if oil prices continue to rise, American shale producers will also ramp up output. This may not happen as swiftly as some expect but many of them are still standing despite OPEC’s best efforts to kill them off. Saudi finances have also been stretched because of low oil prices and the costs of the war in neighboring Yemen. The kingdom’s patience with cheaters is likely to be short-lived, but its only leverage over cheaters is to threaten to re-open the taps itself. In short, there is plenty of scope for this deal to fall short, and to check the recent rally in the price of oil.

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