Since Opec members agreed last week to details of an output cut, no matter where you look the oil market has been in commotion. Futures curves are suggesting that supply concerns are mounting – despite the existing oversupply – or that traders are trying to take up positions for clients who are protecting themselves against price fluctuations.
No doubt the deal, if implemented correctly, will help to address the supply glut that has hammered oil prices since 2014. As a result most producers are bound to win and fewer to lose (or at least, to pay a higher price than others).
The agreement will provide support to shale oil producers in the US. The collapse in oil prices following Opec’s 2014 decision not to curb output has hurt the shale industry, but less than anticipated. US output fell from a peak of 9.6 million barrels per day (bpd) in April last year to 8.58 million in September, according to US energy department data. US oil production might be heading for a recovery, from here. The number of rigs searching for oil is back to the highest level since January. Forward prices for West Texas Intermediate crude crossed US$51 at last week’s closing, which allows some wells to break even in basins including the Permian in Texas, the Denver-Julesburg in Colorado and Stack in Oklahoma, according to the research house Bernstein. It’s expected that US shale oil production will rise with prices.
The world’s largest oil exchanges have also won. Combined volumes of trading of Brent crude on ICE futures Europe and WTI on the New York Mercantile Exchange surged past previous records. The total amount of crude traded last week on both exchanges was the equivalent of about 45 days of global supply, or more than 4 billion barrels traded. Investors flooded into exchange-traded funds that could offer them exposure to US-listed production and exploration companies.
Saudi Arabia and its Gulf Arab allies, including Kuwait, the UAE and Qatar, have agreed to shoulder the bulk of the cuts. On the face of it, Saudi Arabia, which will have to reduce output by 486,000 bpd, looks set to lose. If we assume, which is not as clear, that Saudi Arabia cuts its exports by about the equivalent amount, its oil revenues will increase rather than decrease. If we take Friday’s closing price for Brent crude of $54.46, Saudi oil revenues will increase by $45 million. If the Brent price rises to $60 per barrel, oil revenues will double from its current levels. Oil revenues are also set to increase for the rest of the Gulf Arab producers.
Iran and Iraq appear to have adjusted to new realities. Iraq agreed to production cuts of 210,000 bpd, using third party numbers to calculate its production. The Iraqi authorities believe its own data is showing production to be much higher. There is uncertainty where exactly it will make the cuts, as lots of production is partly run by international companies.
For Iran, Opec agreed to award it an output baseline of 3.975 million bpd – contrary to what most others agreed to, which is that they pumped about 3.7 million bpd in October. Bottom line, Iran has about 90,000 barrels room to pump more oil before reaching the Opec ceiling.
Nigeria and Libya are exempt from the deal. Both are marred by conflict and supply outages are common. If their respective conflicts ease and produce fewer outages, and these countries are able to increase production, they could be significant beneficiaries of the Opec agreement. Libya’s October production was 528,000 bpd, according to Opec’s secondary sources. It is expected to be close to 600,000 bpd for November and the National Oil Company hopes to lift it to 900,000 by the end of the year and 1.1 million barrels next year. Nigeria’s output was reported at 1.628 million bpd in October, following attacks on pipelines. The country’s oil minister says production is already back at 1.95 million bpd, however, this may include as much as 150,000 bpd of light oil called condensate that Opec excludes from quotas. Nigeria hopes to restore output to about 2.2 million bpd.
There is considerable uncertainty about Nigeria’s and Libya’s ability to reach those lofty output targets next year. If reached, Nigeria’s targets will be close to the entire output cuts of the non-Opec members (600,000 bpd). And Libya’s output targets will total those of Saudi Arabia and Qatar combined. Every extra barrel of oil Nigeria and Libya produce will eat away from last week’s agreement.
Russia, too, is set to win from the agreement. Making cuts of 300,000 bpd is significant but many observers expect these to happen through natural rates of decline.
The road will not be smooth for Opec and non-Opec producers. Opec may have to do more than what it agreed to last week for the coming months: another round of cuts might be called for to rebalance the market more deeply. Compliance is central to all winners. And Ali Al Naimi, Saudi Arabia’s former oil minister, said it well and reminded all that: “The only tool they have is to constraint production,” at an event in Washington last week. “The unfortunate part is we tend to cheat.”
John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh.
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