Energy Monitor December – OPEC cuts production, but fails to convince

by: Hans van Cleef

  • Oil prices jumped higher, but remained within the neutral range
  • OPEC meeting outcome: 1.2 mb/d cut by OPEC, 0.6 mb/d cut by Non-OPEC
  • Longer term outlook still uncertain as both OPEC and non-OPEC producers need to deliver their promises
011216-Energy-Monitor-Dec.pdf (312 KB)

Oil price volatility jumped higher

Oil prices increased more than 8% after OPEC confirmed again to cut its crude production by 1.2 million barrels per day (mb/d) as already indicated at the September meeting in Algeria. Non-OPEC producers will cut production by another 0.6 mb/d, of which half will be done by Russia. Brent oil was pushed above USD 50/bbl and WTI traded above USD 49/bbl. Despite this first production cut by OPEC since 2008, oil prices kept trading within the USD 45-53.5 trading range as OPEC failed to surprise.

In its opening statement, OPEC indicated that a rebalancing of the market is already underway. Non-OPEC production fell under pressure and only a moderate increase is expected for 2017. Global oil demand is expected to continue its growth path with 1.2 mb/d growth. One major worry is the large stock overhang which is above the 5y average. Therefore, for a production cut to have a sustainable effect on oil prices, stock levels need to come down as well. OPEC also indicated that market sentiment is driven by short term drivers. However, oil producers – and consumers – need to consider also the medium and longer term prospects. In that respect, OPEC still sees the oil market as a growth market, with an expected global oil demand at 109 mb/d in 2040, or 16 mb/d more than today. To meet future demand, significant investments are needed to prevent a serious shortage in the future.

The agreement

OPEC decided to cut production with 1.2 mb/d as agreed during the September meeting in Algiers. Although Indonesia’s membership will be suspended, its production cut share is divided among the other members. Saudi Arabia will cut production most with almost 500 kb/d, followed by Iraq (-210 kb/d), UAE (-139 kb/d) and Kuwait (-131 kb/d). Also Iran will cut production somewhat (-90 kb/d). Non-OPEC oil producers are said to cut production by 600 kb/d. Russia will cut production by 300 kb/d, and the rest must still be finalised at the meeting in Moscow next week.

The main question remains whether OPEC and Russia will actually deliver. Or, in other words, will these countries stick to this agreement and actually cut production? In the past, OPEC often failed to meet expectations regarding their promises. Moreover, Russia seems to benefit if oil prices increase while keeping its production at current record levels. The Russian economy has been badly hurt by low energy prices and the international sanctions in place

Since the market already anticipated the 1.2 mb/d production cut as announced in September, oil prices did rally today now the agreement was confirmed again. However, this agreement did not exceed expectations and therefore, oil prices even failed to test the October highs. In the near term, oil prices are expected to continue to trade within narrow ranges as it is up to the oil producers to show the market that the production cut will become effective.

Looking ahead

Although reaching an agreement was already quite a struggle, bringing this to practice will be an even greater challenge. Many OPEC members have difficulty to cut production although their fiscal budgets are based on higher oil prices. After all, there is a risk that higher oil prices would trigger a rise in Non-OPEC crude production – mainly US shale oil – which would lead to a shift in market share, rather than a sustainable higher oil price.

Deal or no deal, we still expect higher oil prices in the course of 2017. That is because the market is heading for a balance between supply and demand anyway. Global demand is expected to rise by 1.2 mb/d in 2017, and non-OPEC supply falls under pressure due to a lack of investments in the sector as low oil prices still hurt. A deal may speed-up the process of shifting towards a balance, bringing oil prices towards USD 60/bbl next year. So, if this agreement fails after all, it would only impact temporarily the upside potential of oil prices.