The latest consensus of the world’s largest oil producing nations (OPEC) on curbing the output goes into the implementation period at the beginning of the New Year, the agreement by which OPEC will cut the production 1.2 million barrel a day. The aim of the Vienna meeting has been defined as a solution to reach a new equilibrium in oil market.
The main question is whether the deal will be successful in eliminating a longstanding surplus or is it just a written compliance left undone? Will the reduction amount to almost 2% of global supply work to diminish the excessive production and remove the imbalance and bring a new harmony to the world of supply and demand?
There are some aspects which make us to grow skeptical thoughts about the agreement’s success:
Having a cursory glance at OPEC deals in the past shows that there hasn’t been a good track record in implementation of the promises which leads the market players to emphasize that the noncompliance with the cuts is the major risk. For instance, the production ceiling for OPEC was roughly 30 million barrels from 2012 to 2015 but it was actually producing above that level which was at 31.5 million barrels a day. In the next meeting on December 2015, OPEC decided to maintain production ceiling which reflected its actual output.
The positive point of late agreement is that Russia as a non-OPEC country has committed to cut the output around 558,000 barrels a day. Nevertheless, since there are no formal mechanisms to verify compliance or penalize those who don’t stick their promises, the agreement could be considered as a voluntary act by members.
The potential for U.S. shale production is another key downside risk, as shale industry simply would enjoy a free ride on OPEC’s discipline. The prospect of losing market share to shale producers has already been a big concern for OPEC, since the prices of oil rise in response to the production agreement, shale oil output is expected to increase and consequently would smooth the output cut by OPEC. Some shale producers have lowered their cost of production which allows them to compete economically with many OPEC producers, though some of them even have lower production costs than many OPEC nations. The price of $50 might be signaling for these producers. If the OPEC shortage has been compensated by shale producers, there is a risk that cartel would revise its policy again.
OPEC’s exempted members remain a real risk as Nigeria, Libya continue ramping up output in the wake of oil-related disruptions from internal conflicts. Iran is also considered as an especial case; the country which is trying to take back market share after JCPOA deal.
Although it appears that OPEC members’ new consensus on output cut might have been considered as a major effect on oil market and surge the prices to high level in short run as it is responsible for 30 percent of the oil supply. Market analysts believe that they won’t expect a world of oil $100 per barrel or even $75, but it does mean that market is not going back to a world of $28 any time soon.