Oil Soars off OPEC Agreement to Cut Production

This opinion piece presents the opinions of the author.
It does not necessarily reflect the views of Rigzone.

Oil prices surged in early trading based off newsflow from Vienna that the Organization of Petroleum Exporting Countries (OPEC) had come to an agreement to cut crude output by 1.2 million barrels per day – with Saudi Arabia shouldering about 40 percent of the total proposed reduction.

Beginning in January 2017, and slated to last for six months, the cartel will endeavor to limit production to 32.5 million barrels per day, which was at the low-end of the proposed range discussed in the September Algiers meeting. Data from the International Energy Agency (IEA) estimates that production for the month of October was at or above 33.8 million barrels per day – a record rate for the cartel.

The front-month U.S. West Texas Intermediate (WTI) contract rose 9.3 percent Wednesday on the NYMEX to $49.44 per barrel, while the Brent front-month contract rose 8.6 percent on the ICE to $50.47 per barrel. With the market interpreting the OPEC news as generally positive for oil, many traders engaged in short-covering, which may have accounted for a considerable component in the boost to prices.

Since a deal had been anticipated following the September oil producers meeting in Algeria, markets had been increasingly looking for OPEC to pare back production by at least 1 million barrels per day – in order to accelerate the drawdown of a global crude glut that has plagued oil prices for over two years.

Saudi Arabia, as the de facto leader of the cartel, had a lot at stake in showing that it still holds enough clout to sway oil markets, but also an ability within OPEC to drive cohesiveness among member countries, many of which hold competing economic and geopolitical interests. To that end, today’s attendant bump in oil prices brings Saudi and OPEC some credibility.

But only time will tell if the proposed cuts are adhered to – even implementing the monitoring and tracking of the cuts should prove difficult – and whether or not the proposed reductions actually make a dent in the sizeable crude supply overhang. With no foreseeable global demand catalysts on the horizon, and a large global supply of crude held in storage, it could take months for the market to begin to balance, OPEC cut notwithstanding.

It is worth noting that over the previous five OPEC output cuts, quota adherence averaged about 60 percent. With the majority of OPEC nations heavily leveraged to crude exports to fill government coffers, and growing political and security issues troubling member countries, many will be incentivized to continue the battle for market share – in spite of the deal. Asian buyers of OPEC crude, a chief battleground for vying OPEC members, have already indicated that they will diversify its crude import base to non-OPEC countries such as the United States, UK, Norway, and from Central Asia, if OPEC prices become unpalatable as a result of a cut.

The cartel’s agreement also included a coordinated arrangement with non-OPEC members to cut production by about 600,000 barrels per day, also commencing in January 2017. Russia is expected to bear the bulk of these cuts; about 300,000 barrels per day – but assuming the country will even cut at all should be more in question. Also, creating complexity and uncertainty is which other non-OPEC producers might pick up the slack. With the dramatic fall in commodity prices that have led to political and economic instability for many countries that rely on crude exports as a main source on government revenue, it is unlikely that countries such as Brazil, Kazakhstan and others will have the appetite to participate in a cut, let alone a freeze.

Russia’s energy minister Alexander Novak on numerous occasions has made it clear that the country would be amenable to a coordinated freeze with OPEC – and nothing more. Adding further doubt is the fact that Rosneft’s CEO, Igor Sechin, has unequivocally stated his company plans to grow production in 2017 and beyond (with no intention of cutting back) and has made capital investments toward that aim. Rosneft accounts for approximately 40 percent of Russia’s crude output, which stood at 11.2 million barrels per day in October – marking a post-Soviet record.

All in, the prospect of an OPEC cut – even if there is 50 percent quota adherence – is a definite positive for oil. The markets reacted strongly to the news Wednesday. Just as it did in a negative way Monday, which followed Sunday’s comments from Saudi Arabia’s oil minister Khalid al-Falih who said that without any OPEC cut, oil markets should re-balance in 2017. So, for now, Saudi Arabia can be assured that it still holds power over the markets in a very near-term range. Over the long-term, greater forces, namely U.S. shale production and the implications for changes in global oil flows, could prove to be the greater mover of price.

Delia Morris has worked in the international upstream oil & gas industry for over 13 years, and is currently Director, Global Energy Sector at Stratfor, a geopolitical intelligence firm that provides strategic analysis and forecasting services. Please contact Delia at delia.morris@stratfor.com

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