After two years of fruitless negotiations, OPEC has finally agreed to reduce the crude oil production. It started last September during an Energy Forum held in Algeria. The Organization made the decision public to limit their output to 32.5 mbpd. For more information about this meeting go to our article OPEC agreement. Is it sufficient? However, the most important step was to decide how much the output limit is for each country.
Firstly, what was the reason which made it possible to reach an agreement for the first time?
In 2014, after a few years with oil prices over $ 100 /bbl (despite declining prices as a result of the entry of unconventional US oil), OPEC decided not to make any changes in their extraction levels. Its strategy was to let the market adjust prices so that only “traditional” extraction sources survived. Over time it has been proven that it was a major mistake to underestimate the potential of shale oil.
The United States began to withdraw stimulus measures (Quantitative Easing) launched in 2012. This measure helped sink the price of oil by the strength of dollar. Since then and on demand side, China has been showing signs of slowing down. Lowering its double-digit growth quotas to the current 7%. The collapse of the Stock Exchange during 2015 was a clear signal of alarm and global slowdown.
Finally, the lifting of international sanctions against Iran, after completing the nuclear deal, led the market to absorb 3 million barrels of supply, turning it into a clear oversupplied scenario.
The result was the sinking of the oil price (Brent reference) below 30 $ / bbl. At which they jumped all alarms and where OPEC members began to reconsider their positions. At that time, the battle for price recovery had to deal with the loss of market share and a changing scenario of the energy model where demand for black gold was lower than initially expected. Again, the forecasts failed.
Since then, bilateral meetings began between the major oil-producing countries. Only a consensual agreement to cut or freeze production could correct the bearish market trend. From the very beginning of the year, the markets were expectant to the next sector meetings:
June Meeting 2016: Appointment of the new secretary of the organization. They failed to reach any agreements on output freezing despite intentions to cut 0,7 million bpd..
September Meeting 2016: Informal meeting at the Energy Forum, where the goal of reducing 1.2 mbpd was made public.
November OPEC Meeting 2016: To establish output cuotas of 1.2 million bpd by countries, with the goal to anticipate the equilibrium between supply & demand awaited for 2017.
December non-OPEC Meeting 2016: Where Russia and other producing countries committed to back up the OPEC, rowing towards the same direction.
May 2017 meeting 2017: review of the cut agreement will be reviewed, as well as a possible extension of the deal for the second half of 2017.
Focusing on the last events, last November the 30th had a rendez-vous 13 OPEC members in Viena and agreed to cut their output by 1,2 million bpd (for the next 6 months) based on October volumes, with direct implementation starting in January 2017. A week later, 11 more countries (non-OPEC members) gathered to withdraw from the markets 558.000 further bpd for the same period.
This means that, a total of 24 producing Nations that represent 60% of the global supply of this raw material, have to make cuts up to 2% of the world supply, capping OPEC’s production in 33,05 mbpd.
As it can be seen in the figure above:
Arabia will go back to output levels similar to the early stages of this year.
For Iran, their output quotas, is stablished right below the 4 million bpd, which is effectively their pre-sanction levels of output.
Russia, on their side, increased its output so much halfway through the year that, besides its commitment to cut the output, they will be producing more than they did in 2015.
Nigeria and Libya managed to be exempted from the agreement due to political conflicts they suffered throughout the past months which led to restrictions in its supply.
On top of that, Indonesia has ceased to its membership to the OPEC.
The main hedgefunds have already updated their forecasts (as well as the Energy Information Association), taking into consideration the agreement to diminish supply for 2017. WTI moved to 49 $/b for the first half of 2017 and 54 $/b for the second, and European reference Brent forecasts were respectively 50S/b and 55$/b . EIA also updated world demand forecasts due to China’s and Russia’s demand growing in 1,4 million bpd this year and 1,3 million bpd for the next. These are relatively close levels to those of 2015 (1,8 million bpd) and those of 2016 (1,3 million bpd), it must not be forgotten that this happened under a frame of lower prices, and such values are over the historic average per year (1 million bpd).
The contango is closely associated with the balance between supply and demand, and indicates that operators expect stock levels to be lower in the year after the agreement.
A Great Deal or a Great Lie?
OPEC has a long history of non-compliance with the agreements. The fact that Nigeria and Libya are exempt from the deal has put pressure on the leader of OPEC, Saudi Arabia. For this reason, the parties in the negotiations also agreed to form a special group, being responsible to monitor the implementation of the agreement, both by OPEC and non-OPEC countries. The group its composed of three OPEC members and two non-OPEC.
It should not be set aside, that US producers with barrels above 50 dollars can afford to restart output investments. In fact, last week we saw an increase of 21 new oil platforms (Baker Hughes). The increase in platforms is the largest since July 2015. The active platform availability of drilling in the United States is now in 498, +182 more than in May, which was a minimum of several years.
We can conclude that, there are two likely aspects that could undermine the success of the OPEC & non-OPEC agreement. The first is compliance. Indeed, to make the agreement work, depending much on the actions of Saudi Arabia and Russia, as they account for almost half of the combined production cuts planned. In the meantime the Saudis have increased total volumes, but not as much as their competitors, which means that they have lost market share and so far this year, Russia won their position as the leading supplier of China.
Not only is there a risk of non-compliance of many members (due to geopolitical conflicts) but also a response of 40 percent of global production is still awaiting. A time full of uncertainty and makret movements is coming and we will see this in the forward prices.
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