OPEC members proved skeptics wrong by emerging with a deal to cut production from record levels of 33.8 mmb/d in October to 32.6 mmb/d effective January 2017. The cut of 1.2 mmb/d marks the first of its kind since 2008. Saudi Arabia will take the biggest cut of almost 500 kb/d, followed by Iraq at 210 kb/d. Non-OPEC producers have also agreed to limit output by another 600 kb/d, with Russia offering to take a cut of 300 kb/d in an unexpected move. The deal led to a sharp rally in crude prices, with ICE Brent jumping by 13% to $52.50/bbl on Thursday.
What’s Good
Combined cuts by both OPEC and non-OPEC (1.8 mmb/d) will lead to the drawing down of inventories in 1H 2017, helping to remove some excess volumes from the market. This is reflected in the narrowing front-sixth month ICE Brent spread by around $1/bbl w-o-w to $2.90/bbl on Thursday.
What’s Bad
The boost in crude prices is likely to be short-lived as the key issue is that the cut in production is based on record high levels in October. When compared on a y-o-y basis, the target level of production in January 2017 is in fact what OPEC produced in January this year, which is 32.6 mmb/d. Furthermore, Russia has not stated which level it will be cutting production from. Assuming that it uses October’s post-Soviet high of 11.2 mmb/d as a base, a 300 kb/d cut in January will take it down to 10.9 mmb/d which is flat y-o-y as well. This will essentially bring OPEC and Russia’s total production to January 2016 levels, when crude prices averaged $34.74/bbl.
What’s Ugly
The threat of oversupply continues to loom in the background, as the surge in oil prices opens the floodgates to a potential wave of production from non-OPEC producers such as the US, Canada and Brazil. Iran, Libya and Nigeria (which are exempted from the deal) have the potential to ramp up output as well, making an overall increase in OPEC production next year a very distinct possibility. Another factor to consider is compliance as OPEC does not have the authority to ensure its members do not cheat.
Source: OFE Insights