Following months of global oil market angst, OPEC has pledged to cut its production by almost 1.5 million barrels per day (MMbpd) – a greater target than proposed when the cartel last met in Algeria.
This first OPEC accord in eight years is designed to accelerate the rebalancing of a market that has shown some signs of tightening. Inventories could reach equilibrium in as few as six months, analysts say.
Critically, analysts at Barclays said in a research note, market participants may price this into their calculations before the actual inventories drop.
Barclays said that as a result, oil prices could increase with the emergence of evidence that the market is truly tightening.
“This is not to say that the current environment is easy for the industry – it isn’t – but with OPEC back and effective … it does appear that the worst of the downturn has passed.”
Details Of The Deal:
- OPEC will reduce its production to 32.5 MMbpd – about 200,000 bpd more than initially proposed.
- Saudi Arabia will cut the most – about 40 percent of the total – which comes to 500,000 bpd.
- Iraq will adjust down by 210,000 bpd.
- Russia, coy throughout the discussions, appears to have come onboard with a cut of 300,000 bpd.
- No specifics on waivers for Libya or Nigeria. Indonesia suspended its OPEC membership.
- The deal begins Jan. 1 and runs fox six months. Production levels will hold if market conditions dictate it.
- A meeting Dec. 9 will confirm non-OPEC participation.
The bottom line is this: A chop of almost 1.5 MMbpd to volumes will get inventories down to normal levels by next summer, which would grow confidence that oil could price at $75 per barrel in 2017, David Pursell, Tudor Pickering Holt & Co. managing director, told investors.
What matters most about the arrangement, Pursell said, is in its suppositions. The Organization for Economic Cooperation and Development (OECD) inventories will return to normal in the third quarter 2017 – if the deal holds. Oil prices will respond quickly to OECD inventory declines. And, OPEC assigned a ministerial committee to monitor implementation and ongoing volumes.
“Compliance should be high, but naysayers will suggest OPEC will cheat,” Pursell said. “History suggests that compliance is high initially and does erode over time as oil prices increase.”
The International Energy Agency has estimated that as a group, OPEC currently produces 33.8 MMbpd. In the September meeting in Algiers, the cartel said member nations would target dropping that volume between 32.5 MMbpd and 33 MMbpd.
Designed to boost the oil market’s recovery, the production drop will “accelerate the ongoing drawdown of the stock overhang and bring the oil market rebalancing forward,” OPEC said in a statement Nov. 30.
World oil demand is expected to grow by about 1.2 MMbpd this year and in 2017. OPEC said that underscores that a market rebalancing is underway, but both Organization for Economic Co-operation and Development (OECD) and non-OECD inventories remain well above average. Given the inventory overhang, a lack of investment in 2016 and 2016, as well as massive industry layoffs, OPEC said it’s vital that stock levels are brought down.
Is OPEC Back – Or – Did It Ever Leave?
Criticism of OPEC and early decision to let the market work it’s will and rebalance itself had reached a pitch that questioned whether the 56-year-old organization could be relevant in the post-shale revolution market. That answer is mixed, but largely, affirmative.
“Two years later a much more cohesive OPEC has re-emerged as a force prepared to call upon non-OPEC as well,” Barclays said.
But there are other issues to consider that may alter OPEC’s scope. In the short term, how U.S. shale producers respond will be a factor. The adherence of other non-OPEC producers can also have a role, said Michael Burns, a global energy partner at Ashurst LLP.
Without a doubt, OPEC still has influence, Burns said. And part of what makes this deal remarkable is that it shows the cartel is willing to change course.
“The idea before was to produce as much as possible and now, it’s not to produce as much as possible,” he said.
But ascertaining OPEC’s impact is weeks, months – even years – away, Burns said, as normalized inventories move the level of oil prices.
“If that level is enough for some of the shale producers to make money, then they may well turn the taps on and you may see an adjustment to the price,” he said. “It’s only then that we’ll be able to see the power that OPEC has. To take the logic on, if shale depressed the price again, then OPEC would have to cut further, and the question is, would they be prepared to do that?”
The initial reaction from the oil market was to jump about 8 percent – tantalizingly, just slightly above the $50 per barrel mark – but it won’t necessarily last.
“It’s a big increase on a daily basis, but the point is, that’s only back to the level it was when the conceptual deal was announced in Algiers a couple of months ago,” Burns said. “I’m not sure that what is happening here is going to make a remarkable difference going forward. But I think it does hopefully give a bit of stability – at least in terms of knowing where OPEC stands.”
Showing that OPEC is prepared to reduce supply sends out a strong signal to give stability to prices.
“But I don’t think it gives the signal that we need to see $70 prices tomorrow,” Burns said. “I suspect it may give stability for a period rather than any rapid increase.”(source: Rigzone, written by Deon Daugherty)