Oil Falls on Doubts Over OPEC Output Cuts

Oil prices ended the week 3% lower on January 13th, 2017

o1Oil prices fell on Friday, January 13th, 2017, and ended the week 3% lower on doubts whether the Organization of Petroleum Exporting Countries (OPEC) would deliver its promised oil cuts, as reported by Reuters on January 13th, 2017. Oil prices also fell on concerns over the economic health of the world’s second-largest oil consumer, China, after it reported the steepest falls in overall exports since 2009. Record Chinese crude imports of 8.6 million barrels per day (bpd) in December 2016 helped to buoy oil prices, but worsened fears over China’s overall economic health.

Brent crude futures settled $0.56 lower at $55.45 a barrel, ending the week with a loss of about 3% on January 13th, 2017. US West Texas Intermediate crude futures fell by $0.64 to close at $52.37, also reporting a weekly drop of nearly 3%.o2

Saudi delivers on output curbs

OPEC members agreed on November 30th, 2016, to reduce oil output to 32.50 million barrels per day (bpd) from levels of around 33.24 million bpd from January 01st, 2017, in an effort to prop up global crude oil prices, driving a spike in crude prices since then. Non-OPEC countries including Russia indicated that they would reduce production by about 600,000 barrels a day. Saudi Arabia, OPEC’s largest producer which raised oil production to record levels in 2016, promised to reduce output by 486,000 bpd to 10.05 million bpd. Saudi has delivered on its promise to cut production, and said that its output had fallen below 10 million bpd to levels last seen in February 2015 and that it expects to make even deeper cuts in February 2017.

However, industry watchers are of the view that OPEC is unlikely to deliver fully on its target to cut production, despite Saudi Arabia cutting production more than it had committed to. OPEC’s compliance of 80% would be good and as low as 50% acceptable. Given that the OPEC has an unreliable record of fully complying with its agreements; compliance is voluntary as OPEC has no mechanism to enforce its agreements. Based on statements by producing nations so far, there has been more than 60% compliance by the OPEC so far in 2017.

Compliance concerns haunt OPEC

Earlier in 2009, when OPEC agreed to curb output, it initially delivered 60% of the reduction targets, with compliance peaking at about 80%, according to estimates from the International Energy Agency (IEA). This was enough to help support a rise in oil prices, which began 2009 at $46 and stood at $69 by the end of June 2009. Three months into the last OPEC cut, Saudi Arabia and its Gulf allies showed the highest level of adherence. Saudi Arabia made a larger cut than it had to then, based on the IEA numbers, so history looks set to repeat itself in 2017 if Saudi Arabia sticks to its promise. IEA expects a higher rate of compliance this time around, given that OPEC’s historical average compliance rate is 60%.

Also in 2009, Algeria implemented almost all of its commitment. Venezuelan compliance was at 69%, more than that of Angola and Iran, which both delivered less than half of their pledged reduction. Iraq, which initially resisted joining the cut, said last week that it was reducing production. Venezuela, which pushed hard to bring the global deal together, has also said it intends to deliver on its output cuts.

Russia, the world’s largest oil producer, reduced production by 100,000 barrels a day in the first few days of January 2017. The decline in production is mainly due to unusually cold temperatures in Siberia that have halted work at oil rigs. Among the OPEC nations that were exempted from the production cuts, Libya and Nigeria boosted production in December 2016, even though OPEC supply overall fell. Traders say that even if OPEC cuts its output as agreed, rising US shale output and increasing supply from Nigeria and Libya could offset any reductions implemented by other oil-producing nations.

US oil production set to rise in 2017

While most of the world’s leading oil producers have agreed to slow down in 2017, US production is expected to grow. Data from the US Energy Information Administration (EIA) showed crude production rose notably in the first week of January 2017, particularly in the lower 48 states. Domestic production was about 8.9 million bpd in 2016 and is expected to climb to 9 million bpd in 2017 and 9.3 million bpd in 2018, according to the EIA.o3

While the OPEC is channeling all efforts to reduce the global stockpiles and in turn increase crude oil prices, EIA data shows that US crude stockpiles were at 485.7 million bpd as of January 2017, higher than the levels of 478.2 million bpd in December 2016, and much higher than 468.7 million bpd in January 2016.o4

Meanwhile, Baker Hughes reported on January 13th, 2017 that its weekly count of US oil rigs fell for the first time in 11 weeks. The count fell by 7 rigs to a total of 522, compared to 515 oil rigs in operation a year ago.

o5US producers did not pledge to cut production and have signaled they will increase production as prices strengthen. If US production increases too much while other countries cut back, domestic producers will gain global market share in a move that could hurt the other countries. US production doubled in seven years, and OPEC members chose not to cut quotas because they did not want to give up market share to US producers.

Focus shifts to May meet

Overall, oil companies would continue to benefit if global demand continues to increase and the global storage glut gradually reduces. The oil price over the next few years will depend heavily on whether global production continues to outpace demand or if it slows enough to let consumption catch up.

Moreover, the strength of the OPEC deal will depend on whether all parties deliver on their commitment. Saudi Arabia and its Gulf allies, the UAE, and Kuwait, have traditionally stuck to their cuts, but some others have not, particularly when prices are low. Any doubt in the market could once again see prices come under pressure. OPEC will meet again on May 25th, 2017, at which point it intends to extend the cuts by another six months.

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