Are OPEC’s Cuts Adding Up to Lower Oil Prices?
Traders look beyond group’s compliance numbers to measure impact of output pledge
Measuring the success of OPEC’s production cuts has never been harder.
Oil traders say they aren’t just looking at the most recent numbers from the Organization of the Petroleum Exporting Countries showing it is complying with its pledge to cut almost 1.2 million barrels a day from the global market. Instead, they are watching for signs that U.S. oil output is growing, that oil storage is falling and that other big producers like Russia are curtailing their flows of petroleum.
The complicated math has helped put a cap on oil prices and kept crude trading in a roughly $5 band between $51 and $56 a barrel, following a 20% surge in prices after the Nov. 30 OPEC deal.
The latest evidence of this came Monday, when OPEC—notorious for not following through on its own agreements—delivered an optimistic report with numbers showing almost full compliance with its pledge. Oil prices fell anyway, with Brent dropping 2% to $55.59 a barrel.
The main reason for the fall in prices, traders and analysts say, is that production increases were baked into OPEC’s agreement, blunting the cartel’s ability to force traders to draw down the vast supplies of oil stored in tanks across the world.
In 2009, when OPEC said it would cut more than 4 million barrels a day to stabilize prices during the financial crisis, there was only one exception: Iraq. This time, the cartel’s agreement exempted two big producers, Nigeria and Libya, and allowed Iran to increase a bit, too.
Including Nigerian and Libyan output, BNP Paribas put OPEC’s compliance rate at 77%, and if Nigerian output keeps growing, that could fall to 63%, BNP said—about the same level as in 2009. U.S. Energy Information Administration numbers suggest OPEC cuts, including Nigeria and Libya, amount to about 75% of what it promised.
Another wild card is non-OPEC production. Russia and 10 other countries said they would cut a total of 558,000 barrels a day this year, but the deal was light on details, making it difficult to judge compliance, traders said.
Russia, the world’s largest producer, cut 100,000 barrels a day in January, the International Energy Agency said last week, but that was down from post-Soviet records and less than the 300,000 barrels a day it agreed to cut. Goldman Sachs estimates total compliance by OPEC and 11 non-OPEC countries, which agreed to jointly cut output in December, at around 85%.
“It is a numbers game,” said Doug King, chief investment officer at RCMA Asset Management and manager of that firm’s $230 million Merchant Commodity hedge fund. “Despite good noises from OPEC, there are important exemptions and we don’t really know what’s going on in Russia,” he added.
Another wrinkle for the deal is U.S. shale producers, which are using the bump in prices over the past two months to jump-start output. OPEC on Monday doubled its estimate of non-OPEC production growth in 2017, blaming “a pick up in drilling activities and investment in the U.S.”
“The panic is that [the OPEC cuts] are giving a lifeline to shale production,” said Helima Croft, chief commodities strategist at Canadian bank RBC Capital Markets.
Increased U.S. production has some market participants questioning whether inventories will decrease much this year. OPEC’s goal was to draw down more than 300 million barrels from storage to bring supply back into balance with demand and spark a sustainable price rally.
The compliance mathematics matters for investors who have amassed a record number of bullish bets on oil prices after OPEC clinched the production deal. Wagers on rising U.S. oil prices by hedge funds and other big money managers are near their highest point in more than 10 years of record-keeping by the Commodity Futures Trading Commission.
That carries risks for prices, Mr. King said. “There’s a lot of complacency out there. If these bets start to unwind, it will be a bloodbath.”
To be sure, OPEC’s swiftly executed production cut has helped the group’s credibility. For years, it had been considered all but dead, incapable of putting aside its internal disputes and geopolitics.
Jim Krane, an energy studies fellow at Rice University’s Baker Institute in Houston, said the agreement showed that “archenemies” such as Saudi Arabia and Iran could make a deal. Also, new satellite technologies mean oil shipments are now “very transparent,” he said, adding, “Cheating is very easy to detect.”
But there are also concerns that the current levels of compliance with the cuts won’t last.
Saudi Arabia says it has cut almost 800,000 barrels a day by itself, far more than the 486,000 barrels a day it agreed to and carrying the load for countries that have fallen short of their goals, such as Algeria, Iraq and the United Arab Emirates. The kingdom often reduces output in the winter anyway for maintenance, and it isn’t clear how long it will maintain low production levels.
Meanwhile, Iraq and Libya could boost production even more, says Olivier Jakob, head of Swiss consultancy Petromatrix. Iraq’s largest field is undergoing maintenance, while Libya has said it could increase output by a further 200,000 barrels a day.