OPEC's Production Cut Has Limited Upside for Oil Prices

Oil producers’ group OPEC and its 10 non-OPEC allies sprung a surprise at the recent meeting of ministers and envoys by announcing a deepening of output cuts to “rebalance the market” and support crude prices.

Previous cuts outlined by the 24-strong producers’ agreement were pegged at 1.2 million barrels per day (bpd) and were set to expire in March 2020. However, following long and somewhat fractious deliberations spread over December 5-6 in Vienna, Austria, what emerged was not only a rollover of the cuts until the summer of 2020, but a deepening of the level by 500,000 bpd.

Key oil ministers including Saudi Arabia’s Abdulaziz bin Salman were at pains to stress that the additional number would not be a paper adjustment but indeed a real-terms cut totalling 1.7 million bpd. Unsurprisingly, much the burden will fall on Saudi Arabia's shoulders.

Bin Salman announced the kingdom would "voluntarily" cut by 400,000 bpd, extending its contributions by 167,000 bpd. The move would keep Riyadh's headline production at 9.744 million bpd. Russia – the biggest of the non-OPEC producers participating in the cuts – promised to increase its cuts by 70,000 bpd, with the country’s oil minister Alexander Novak expressing the opinion that Moscow wants to avoid "oil market turbulence in 2020."

Other producers participating in the cuts, often accused of not doing their bit, also queued up to state on record that they would comply with their end of the bargain. And if that wasn’t enough, all OPEC and non-OPEC participants – labelled OPEC+ by the market – also said they would rigorously monitor activity opting to meet again in March and June 2020.

It is clear that OPEC+ appears to be pretty serious in lowering production as a group and wants the market to feel that. While the strategy is a bold one for the producers involved, oil price direction for 2020 remains uncertain.

From OPEC’s perspective, supply-side arguments remain as complicated as ever. The market’s standard focus on additional barrels often falls on U.S.; currently the world’s largest crude producer. Most surveys for 2020 see the country’s production in the 13.1-13.4 million bpd range.

However, the market can also expect additional barrels from Brazil, Canada, Guyana and Norway taking the total 2020 non-OPEC production growth to 2.3 million bpd, according to the International Energy Agency (IEA).

While some at OPEC aren’t complying as well as they should, others are doing more than their allocated share, cutting in some cases by over 140% of the figure allocated to them. According to Bin Salman, in the unlikely event of such a level compliance be replicated by all 24 OPEC+ producers, their cuts could be as high as 2.1 million bpd.

But even at that level of compliance, the figure would fall short of the non-OPEC growth figure resulting in a loss of market share for OPEC+. That’s even before the potential for demand decline is factored in. Most surveys and forecasts put global demand growth for 2020 in the range of 800,000 bpd to 1.4 million bpd. I am inclined to vote in favour of the lower end of the range given the macroeconomic uncertainties on the horizon.

Of the big five crude importers, the U.S. is turning less to the global market, and primarily for heavy sour crude, China’s demand growth is nowhere near the rate it was at the turn of the decade, while Japan and South Korea are importing less crude on an annualized basis. Only, India’s demand growth is holding firm and that too is looking uncertain.

Add to that the U.S.-China trade spat which is a long way from being resolved. It is unlikely to be settled anytime soon given the number of false dawns and extensions to talks the market has had to endure.

Other macroeconomic uncertainties such as drop in German, Chinese activity, Brexit uncertainties and negative outlooks on a range of emerging markets from Argentina to Turkey are also clouding the demand picture.

Take both sides of the coin, and all OPEC+ members have done is exceed market expectations of a rollover of the existing cuts by deepening them further. An inescapable fact remains that the group is losing market share, and will continue to do so, all probably just to hold the oil price floor above $60 per barrel using Brent as a benchmark.

Ultimately, the move lacks and an exit strategy and all what OPEC and its allies have done is given up yet more ground. That conceded ground would be happily taken by non-OPEC players storing up trouble for OPEC+ and put its discipline of complying with the ongoing cuts under pressure.

Furthermore, many of the 14 OPEC and 10 non-OPEC producers who have signed up to the cuts have proven unreliable in the past on the issue of compliance. Should the group’s discipline break to the Saudi’s frustrations resulting in an opening up of the taps, all bets are off. Whichever way you look at it, for now the price upside remains limited and uncertain despite OPEC+ action.

Gaurav Sharma is an independent oil and gas analyst with over 15 years experience. He provides regular market commentary for events, publishers and broadcasters. Follow him on Twitter @The_Oilholic or email at gaurav.sharma@oilholicssynonymous.com