Oil Spikes as Saudi and Non-OPEC Producers Commit to Deeper Cuts

Saudi Arabia ready to cut oil production to below 10 million bpd

o1In a sign that bodes well for the troubled oil market, crude prices advanced to the highest since July 2015, after Saudi Arabia committed to cut its crude output by more than earlier agreed and non-OPEC countries including Russia pledged to pump less in 2017, as reported by Bloomberg on December 12th, 2016. The Organization of Petroleum Exporting Countries (OPEC) scored a major victory by clinching a major pact at a gathering of member nations in Vienna on November 30th, 2016, to cut oil production in an effort to prop up global crude oil prices. The deal is expected to normalize record global oil inventories, and is OPEC’s first production cut in eight years.

OPEC was under pressure to reach an agreement to stabilize the market and eliminate the global oil glut, where crude remained capped below $50 a barrel. OPEC, which met on the sidelines of the International Energy Forum (IEF) in Algeria from September 26-28th, 2016, agreed to reduce oil output to 32.5 million barrels per day (bpd) from the current levels of around 33.24 million bpd, driving a spike in crude prices since then. Since OPEC’s September 2016 meet, crude oil prices have been hovering near $48 per barrel, up from under $30 a barrel at the start of 2016.

More importantly, OPEC scored a major triumph when it was able to patch up disagreements between the group’s three largest producers, Saudi Arabia, Iran, and Iraq, and end a free markets era that started in 2014. Most strikingly, non-OPEC nation Russia and the largest oil producer in the world, agreed to unprecedented cuts to its own output for the betterment of the overall oil industry, marking the first coordinated action with Russia in 15 years.

In November 2016, OPEC output rose to an estimated 33.79 million bpd on increases from Libya, Nigeria, and Angola. If OPEC indeed implements the output cut in 2016, market watchers believe that the deal could add $7 to $10 to oil prices in H1 FY17, giving cause for hope to oil producers as crude prices continue their recovery from a 12-year low.

Crude jumps to 17-month high

Saudi Arabia stated that it is ready to cut oil production to below 10 million bpd, a level it has sustained since March 2015, while Russia and several non-other OPEC countries pledged to curb output by 558,000 bpd in 2017. This marks the first deal with OPEC and non-OPEC rivals since 2001. It also underscores a major effort on the part of Saudi Arabia, the largest OPEC producer with output of more than 10.7 million bpd, on par with Russia and the US, to eliminate the global glut. Together, these three nations account for a third of the world’s oil production.

Source: Bloomberg, CDU-TEK
Source: Bloomberg, CDU-TEK

Saudi Arabia agreed with the OPEC on November 30th, 2016, to cut its production to 10.06 million bpd, down from a record high of nearly 10.7 million barrels in July 2016. The non-OPEC reduction is equal to the anticipated demand growth in China and India in 2017, according to data from the International Energy Agency (IEA). The OPEC and non-OPEC pact encompasses countries that produce about 60% of the world’s crude, but excludes major producers such as the U.S., China, Canada, Norway, and Brazil.

Reacting to the news, West Texas Intermediate for January delivery rose $1.33 to settle at $52.83 a barrel on the New York Mercantile Exchange on December 12th, 2016. It is the highest close since July 14th, 2015. Total volume traded was about 81% higher than the 100-day average. Brent for February settlement climbed $1.36 to $55.69 a barrel on the London-based ICE Futures Europe exchange. The contract closed at the highest since July 22nd, 2015.

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Market balance in near sight

The main impact of the non-OPEC collaboration is to pull the global market into balance, if not in deficit, in Q2 FY17. Russia pledged to cut output by 300,000 bpd next year, down from a 30-year high of 11.2 million bpd in November 2016. Mexico agreed to cut 100,000 barrels, Azerbaijan by 35,000 barrels and Oman by 40,000 barrels. Kazakhstan pledged to cut output by 20,000 bpd after coming under strong diplomatic pressure, despite the country’s output rising after a giant oilfield that started production in October 2016. However, the most important aspect is compliance, as historically OPEC and non-OPEC countries have cut far less than promised. In 2001, for example, Russia promised to reduce output, but instead raised it in 2002.

US rig count up

o5OPEC estimates that the ideal price range for crude would be at $60 a barrel, as higher levels risk sparking a recovery in competing supplies from the US. Meanwhile, economists have warned that crude oil prices could recede over the next few months as other producers, especially US shale drillers, are standing ready to fill the supply gap. US crude production has already risen by more than 3% in 2016 to 8.7 million bpd, as its drillers have slashed costs in an effort to compete in a lower price environment. According to Baker Hughes data, the US rotary rig count was up 27 at 624 for the week ended December 09th, 2016.

OPEC-Russia deal could wipe out 50% of glut

According to Bloomberg data and the IEA, the record inventories accumulated since 2014 will dwindle at a rate of about 760,000 bpd in H1 FY17, if the OPEC and 11 other oil producers implement the supply cuts. Over the six months covered by the deal, that would remove 46%, or 139 million barrels, of the 300 million-barrel stockpile surplus that OPEC aims to clear.

Bringing about a crude-supply deficit of 760,000 barrels a day in H1 FY17 would require the OPEC to fully implement its 1.2 million barrel-a-day cut, a goal that is challenged by rising production from exempt members Libya and Nigeria. Among non-OPEC producers, it would be crucial that Russia follows through on its pledge to curb output by as much as 300,000 bpd.

Market estimates show that OPEC crude supply in H1 FY17 would be about 400,000 bpd lower than demand, subject to complete compliance with the deal. If the 11 non-OPEC nations stick to their pledges, their combined output would be 17.97 million bpd over the six-month period, almost 360,000 bpd lower than the IEA’s current forecast.

Source: IEA, OPEC
Source: IEA, OPEC

The strength of the deal will depend on whether all parties deliver on their commitment. Saudi Arabia and its Gulf allies, the U.A.E. 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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