OPEC succeeded in pulling off what many thought was impossible, overcoming mutual disdain and mistrust to reach a deal on reducing its oil output. Oil prices skyrocketed on the news, up more than 12 percent since the agreement was announced last week. But what if there is much less to the deal than meets the eye? What if OPEC does not actually follow through on the promised production cuts?
Several days of strong price gains ran into a wall of skepticism on Tuesday, after fresh data showed that OPEC’s November production was much higher than anticipated. The cartel’s output jumped from 33.6-33.8 million barrels per day (mb/d) in October to a record high 34.19 mb/d in November. The gains came from Angola, Gabon, Indonesia, Libya, Nigeria, Iran and Iraq.
If OPEC is to succeed in bringing production down to its stated target of 32.5 mb/d by January, it will now need to cut 1.7 mb/d, not just the 1.2 mb/d that it announced last week. But a few of those countries (Libya, Nigeria, Indonesia) are exempted from the limits agreed upon in the latest deal. That means that the rest of OPEC will need to shoulder steeper cuts if the cartel is to hit the 32.5 mb/d threshold. However, the group did not discuss this contingency – who should cut even deeper – so there is little reason to think that any individual member will voluntarily cut more than they agreed to just so that the collective output comes in lower.
On top of all of that, two key OPEC countries exempted from the deal – Libya and Nigeria – have a large volume of oil production capacity offline. Libya has already added 200,000 barrels per day in production gains this year, taking output above 500,000 bpd. They are hoping to ultimately bring output up to 900,000 bpd next year. In a sign that they could be on their way to that target, ISIS was ousted from Sirte, its last major foothold in Libya. The war-torn country still suffers from a political vacuum and splintered allegiances, but the risk to supply is likely on the upside. Nigeria too has roughly 0.5 mb/d of capacity offline because of pipeline attacks. It won’t be easy but Nigeria could bring output back online in 2017. The two OPEC countries could overwhelm the effect of the deal.
That suggests that OPEC won’t actually bring output down to the stated level of 32.5 mb/d, which essentially means that OPEC oversold its deal to the oil markets. Recognizing that the Vienna deal is not as rock solid as previously thought, investors sold off oil on Tuesday, with WTI and Brent each down more than 2 percent.
The OPEC deal may hit another stumbling block this weekend as negotiators are set to meet with non-OPEC countries to discuss their cuts. Non-OPEC producers agreed to cut an additional 600,000 barrels per day, and OPEC made their 1.2 mb/d in promised cuts contingent on non-OPEC participation. So far, four countries are set to attend (although 14 were invited), including Russia, Oman, Bahrain and Azerbaijan. Russia alone had agreed to slash 300,000 barrels per day from its production total.
But there are reasons to doubt that non-OPEC will be able to deliver. Russia’s oil production, for example, hit a post-Soviet record high in November at 11.21 mb/d, up roughly 500,000 barrels per day from August levels, just before Russia agreed in principle to cap production at the Algiers meeting. In that context, its cuts of 300,000 barrels per day seem much less impressive. Moreover, Russian officials said the cuts would be implemented gradually in 2016, not immediately in January as OPEC had hoped.
This sets up the possibility that this weekend’s OPEC/non-OPEC meeting could disappoint. OPEC’s Secretary-General Mohammad Barkindo is hyping the summit, saying the cooperation will be “the first time OPEC [and] non-OPEC will agree to a joint, binding supply-management agreement,” according to the WSJ. With expectations high, any faltering in the negotiations could undermine the bullish case for oil. “Will Russia cut 300,000?” former Saudi oil minister Ali al-Naimi said in reaction to the agreement last week. “I don’t know. In the past, they didn’t.”
Others voiced similar skepticism after the deal was put in place. “It remains unclear to us which other non-OPEC producers might be willing to commit to or even claim production cuts,” JBC Energy, a Vienna-based oil consultancy, wrote in a research note. “Although OPEC officials spoke of a 300,000 barrel-a-day contribution from Russia towards an overall 600,000 barrel-a-day non-OPEC cut, we remain quite skeptical that this will actually happen.”
That brings up another possibility – that several or most of the participants, both OPEC and non-OPEC, cheat. The cartel has a poor track record of living up to production quotas.
Dennis Gartman, author of The Gartman Letter, told CNBC that OPEC will undoubtedly cheat on their agreement. “It’s only a matter of time until they do cheat…They’ll begin cheating by February or March. Always have, always shall. It’s not going to change.” Gartman also expressed skepticism about the broader rally in oil prices, citing a questionable commitment from Russia and the resurgence of U.S. shale. “Every fracker worth his money is going to make money at $56. They’re going to be hedging that aggressively. It’s going to be hard to push WTI much passed $52 [per barrel].”
Former Saudi oil minister Ali al-Naimi admitted last week following the historic deal that sometimes OPEC cuts are not all that they are cracked up to be. “The only tool they have is to constrain production,” al-Naimi said at an event in Washington, D.C. “The unfortunate part is we tend to cheat.”
By Nick Cunningham of Oilprice.com