by Sara Vakhshouri
OPEC got what it wanted with Wednesday’s agreement to cut oil production: higher prices.
But that is a double-edged sword, as those higher prices could lead to a surge in production by U.S. shale producers and others outside the Organization of the Petroleum Exporting Countries. And if those producers exacerbate the supply glut that has plagued the market, it will be much more difficult to reach another deal when this one expires in six months.
OPEC producers need higher oil prices to solve their own budget woes. But if they start losing market share, their resolve to prop up prices by squeezing supply could rapidly disappear.
For now, though, the deal to cut output from 33.7 million barrels a day to 32.5 million barrels a day is likely to stick. Saudi Arabia’s targeted production of 10mbd in 2017 is in line with its sustainable production capacity. Iran cannot add much more oil to its October output, as it has already added its maximum short-term capacity; to raise its production beyond 50-90kbd, it needs international investment and technology.
Iraq and other members are also hoping for higher income due to the higher oil prices. Hence we could expect that the deal stay in place at least for the first quarter of 2017. Prices for Brent LCOG7, -0.75% which jumped nearly 13% this week, now should stay above $50 for at least the first quarter of the next year.
Here’s how the deal shakes out for three big oil producers:
Saudi Arabia was the big winner of the November deal. The country’s two-year-old strategy of tolerating low oil prices, sparked by an unwillingness of OPEC and non-OPEC producers in 2014 to reduce production in the face of a supply glut, clearly paid off. By not reducing production then, the Saudis gained market share, filling much of the void left by Iran’s sanctions-related supply cut of 1mbd.
The November deal means the Saudis must reduce output by 486,000 barrels a day, to 10.05 million barrels a day. But this number is only 123,000 barrels below its 2015 average daily production and, indeed, higher than in previous years. This means the Kingdom’s output is remaining at its sustainable production level of around 10mbd, or nearly one-third of overall OPEC output.
Since 2012, Iran has lost more than 1 million barrels a day of production and export as sanctions tied to its nuclear program have hit. Losing its status of second-largest OPEC producer to Iraq was, in an understatement, not an easy adjustment for the country. Iranian officials insisted in recent OPEC gatherings that the country would neither freeze nor cut its production, given the hit output has taken in the last four years.
On Wednesday, OPEC agreed to use the country’s production of 3.97mbd in the final quarter of 2015 — the highest level in 16 years — as the base for calculating any cuts. This was a nod to Iran’s historically high production and of extreme sentimental importance to the country. Like other contributing members, Iran was asked to cut 4.5% of its production. But since Iran’s oil output has already fallen by more than that, to 3.7 mbd in October, it actually can increase production by 90,000 barrels a day and still comply with the November accord. By carefully spelling this out, OPEC is trying to prevent oil traders from being surprised by an uptick in Iranian output.
Losing market share to Russia and non-OPEC producers in general has always been a major fear for the OPEC producers. As part of this deal, Russia, the largest non-OPEC producer in 2016, agreed to cut 300,000 barrels a day of its production “based on its technical capacity.”
Even though Russia’s support for the deal was encouraging for the market, there is no evidence that Russia has actually supported any OPEC decisions to cut production in the past beyond official statements.
Moreover, it isn’t clear what technical capacity actually means: “not add” 300kbd of new production, or an actual cut from its production today?
At the moment, however, there is no sign that Russia is seeking to offset any of OPEC’s reduced output.
Reprinted, with permission, from MarketWatch.