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OPEC Attempting To Cut Oil Production

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The Oil Producing and Exporting Countries cartel is making a run at cutting supplies for the first time since 2008. The dynamics of the new century have taken a lot of clout away from the Arabian Penninsula and other major oil exporters but they are seeming to cooperate and rally back in a six month venture to cut output and raise prices.

Oil jumped more than four dollars a barrel on the news Wednesday, and gained over two dollars more in Thurdsday trade to stand above $51.00. A year ago, crude oil was ten dollars a barrel cheaper.

Who wins and who loses is yet to be determined as the individual countries that are members, and non-members of OPEC have often violated their production quotas as their leadership was dependent on the oil revenues. Russia, a non-member, has agreed to cut its production by 300 thousand barrels per day during the first half of 2017.

On the demand side, the developed countries that are net oil importers have taken measures to reduce their reliance on foreign oil by either increasing the use of wind, solar and other renewable energy or they have begun to explore higher cost domestic sources of fossil fuel. The United States and Canada were able to drill for oil in the Baakan region due to very high oil prices in decades past.

Response from the oil world was reported by Tony Starkey, Manager, Energy Analysis, Platts Analytics

“The oil world is emitting a collective sigh after holding its breath in anticipation of the OPEC meeting in Vienna where the organization agreed to cut output by 1.2 MMb/d, a sizeable cut that is at the top end of the range suggested in Algiers. Perhaps most surprising, however, was that this is in addition to an agreement from non-OPEC countries to also cut production by 600 Mb/d, 300 Mb/d of which is to come from Russia. In total, that represents a 1.8 MMb/d cut in total crude production, far surpassing anyone’s expectations. One caveat is that this cut is only good for 6 months beginning January 1st, with the policy which was referred to as “an adjustment” to be revisited at the next meeting to be held on May 25th, 2017. This is important because much of 2017’s oversupply was to be confined in the first half of the year when demand is seasonally weaker than the back half of the year.

The 1.8 MMb/d number, however, is easily attributable to OPEC’s own supply and demand analysis, where they forecast in their most recent monthly report, that the world would be oversupplied by nearly 1.8 MMb/d in the first half of 2017 should OPEC’s production have stayed at its current levels. That differs fairly significantly from both the IEA and EIA who, while admitting oversupply would persist in the first half of 2017, only pegged that oversupply at about half the level, or roughly 900 Mb/d. Should the EIA and IEA’s estimates more closely align with actuality, and OPEC and non-OPEC countries succeed in implementing the stated production cuts, we would be looking at a market that is undersupplied by nearly 1 MMb/d in the first half of the year.

Other more administrative news to emerge from the meeting was that Indonesia would cease its membership within OPEC, less than a year after they were readmitted. This is likely a result of Indonesia refusing to cut their production since they are actually a net importer of oil. There will be a ministerial monitoring committee with members from Kuwait, Venezuela, and Algeria, to oversee compliance with the stated cuts, and that compliance will be measured against secondary source estimates for OPEC countries.

This is a drastic shift in policy for OPEC, whose key members have argued about retaining market share being more important than supporting higher oil prices. This cut is obviously going to reduce their percentage of global market share relative to non-OPEC, especially when you shift Indonesia from the OPEC column to the non-OPEC column.

The oil market has reacted in kind, moving up nearly 9% at the highs of the day, especially as concerns about the deal falling apart accelerated into the final hours before the meeting commenced. With the agreement comes the sense, now, that 2017 should experience a rebound in oil prices, as what would have been yet another year of oversupply theoretically becomes one of rebalance and deficit.

Away from the immediate impact to the market (to begin one month from now), the longer term implications are obviously how non participating non-OPEC countries respond to an increase in prices…most notably, the US. Even before this agreement, expectations for US production has been increasing throughout the year. The EIA’s estimates for Lower 48 ex-GoM (Gulf of Mexico) production in 2017 bottomed out in April at 5.76 MMb/d. Their latest forecast is for it to be at 6.43 MMb/d. Given the presumed increase in prices that the proposed cuts will provide, we can assume that those forecasts for US production will likely continue to rise in the months ahead.”

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