Can OPEC Resist The Temptation To Cheat?

By Gregory Brew

OPEC’s monthly report for February was released Tuesday morning, and total output appears to have fallen from 32.097 million bpd in January to 31.958 million bpd. Members which agreed to the production freeze and cuts were able to reduce production from 29.9 million to 29.7 million bpd, with Iraq and the UAE continuing to pump above agreed-upon levels, exceeding quotas by 63,000 and 51,000 bpd, respectively.

This is pretty good news, but in light of last week’s massive U.S. inventories and the subsequent decline in prices from $54 to $47, the report isn’t enough to indicate a reversal in OPEC’s suddenly declining fortunes.

Secondary source verification indicated that Saudi production continued to fall, to 9.797 million bpd. According to direct communication, rather than continue its cuts, the country actually increased production between January and February, from 9.748 million to 10.011 million bpd.

While total Saudi output has fallen significantly since last year, by as much as 450,000 bpd, the monthly data would indicate that further deep cuts by OPEC’s leading producer are unlikely, at least until a new agreement is reached. Saudi Arabia has shouldered much of the burden of the OPEC cuts, but at last week’s CERAWeek 2017 conference, the national energy minister indicated that Saudi Arabia would be unwilling to continue cutting its own production just to give a boost to prices: it would take more concerted action by OPEC to achieve that goal.

American production also spiked after the deal was announced, rising above 9 million bpd, and the increases are likely to continue. The EIA estimates that U.S. shale drillers will increase production by 109,000 bpd in April, with the most significant rises coming from the Permian and Eagle Ford fields in Texas and New Mexico. OPEC data suggests that world oil supply has fallen since November, from over 98 million bpd to 94.9 million bpd, with a decline of 200,000 bpd coming in February. This would indicate that the cuts by OPEC and non-OPEC producers have largely left their mark, that production will only rise from here, and that the immediate impact of the OPEC deal has been felt.

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Now that the initial impact of November’s agreement to freeze production seems to have worn off, speculation has begun regarding OPEC’s next move. The freeze and production cuts removed about 1.2 million bpd from markets and brought a tightening of supply, yet this was almost entirely offset by increases in production from certain OPEC members, including Iran, which were exempt from the freeze.

The sentiment that OPEC’s outward unity is starting to crack has contributed to the downward turn in price and the emerging bearishness surrounding oil futures. Breaks in OPEC’s show of unity include Iraq’s continued desire to boost production to 4.5 million bpd. The February report indicated that it is pumping about 91,000 bpd above the intended quota, though this is still a reduction from its pre-November production level of 4.6 million bpd. Yet Iraq, rather than contribute as Saudi Arabia has done to the overall cuts, continues to contribute what Riyadh sees as the bare minimum.

There are also the Russians to consider. Saudi Energy Minister Khalil Al-Falih expressed his irritation last week that Russia isn’t doing its part, and that Saudi cuts would not make room for “free riders” who could profit from higher prices. Russian cuts contributed to non-OPEC production decline of 558,000 bpd, but the Russian company Rosneft has already expressed doubt that the cuts will last past the six month mark, as was originally intended. The Russian energy firm has indicated that it feels a real balance in the market will require action by consumers and regulators, not just producers, a tacit admission that the experiment to cut production and bring back high prices has failed, at least for the time being.

With U.S. shale production likely to boom, Russia on the fence and OPEC’s leader unwilling to shoulder more of the burden, the big question facing analysts is what will OPEC do next? While the settlement of the production agreement last year was a surprise, additional cuts or a decision to extend the existing cuts for another six months may be nothing short of miraculous: if prices stay low, and seem to stay that way for the immediate future, the temptation by OPEC members to ramp production back up and take back market share, trying for a second time to put U.S. shale out of business, will be a strong one.

By Gregory Brew for Oilprice.com

 

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