Oil prices higher and steady as OPEC starts cutting production

Sunday 25/12/2016
Saudi Energy Minister Khalid al-Falih addresses a news conference after a meeting of the Organisation of the Petroleum Exporting Countries (OPEC) in Vienna, Austria, on December 10th.

Beirut - Oil prices have increased into a steady range of $50-60 a barrel as the Or­ganisation of the Petrole­um Exporting Countries (OPEC) informs companies of cuts for their January liftings.

OPEC members pledged to reduce production 1.2 million barrels per day (bpd) as of January 1st and non- OPEC producers are to reduce pro­duction by 600,000 bpd. Two dozen countries are involved in the cuts.

Oil prices dropped approximately 80% from mid-2014 through early 2016, to less than $30 a barrel. Most of the major world oil producers have signed on the November 30th Vienna accord and the following OPEC and non-OPEC agreement of December 10th.

The main country that has not par­ticipated is the United States, which is the number one liquids (crude oil and condensates) producer at around 13.6 million bpd; the number one oil consumer, at just more than 20 million bpd, the number one im­porter of liquids at 9.6 million bpd and the number three of liquids ex­ports at about 4.8 million bpd.

Stability of oil prices is strategical­ly important for exporters and im­porters. Producing countries need stable oil prices to draw balanced state budgets over a number of years and carry out long-term planning, as most producers depend heavily on funds from oil, which account for 90% of some countries’ public rev­enues.

Consuming countries also need stability to ensure a balanced supply and demand, both in the short and long terms. The 2016 OPEC World Oil Outlook projected that the world will need 109 million bpd by 2040, an increase of more than 16 million bpd.

The collapse of oil prices dur­ing the past two years has slowed — even halted — several major oil development projects. The world needs more oil not only to meet ris­ing demand but to replace declining production from ageing fields.

These are some of the reasons that convinced countries to join the Vienna accord and the following OPEC-non-OPEC accord. The pro­ducers realised the need for the eco­nomic stability of their countries. The major oil firms expressed fears publicly of the shortfall in invest­ments and the future consequences upon global supply and demand.

Ministers of oil-producing coun­tries had lengthy talks throughout second half of 2016 before announc­ing unanimous agreement. The two biggest producers — Russia and Sau­di Arabia — coordinated policies to ensure the conclusion of the agree­ments.

Much hard bargaining took place to placate this or that country. Mos­cow, for example, demanded that OPEC had to reach unanimity be­fore Russia cooperated, a move that obliged Tehran and Riyadh to modi­fy their positions and objections.

Saudi Arabia waited until non- OPEC countries pledged to cut pro­duction 600,000 bpd on December 10th to announce that Riyadh was ready to cut its production even further, if necessary. That move reminded markets, even if cau­tiously, that Riyadh was willing to undertake a higher responsibility to balance supply and demand, if the pledged cuts were not sufficient or if they were not complied with fully.

The time has come for the produc­ers to deliver their pledges. Previous practices following production cuts have demonstrated that there is strong compliance immediately af­ter the agreements but that seepage follows. It is expected that compli­ance will be high during first quarter 2016. OPEC ministers have sched­uled a meeting in Vienna for late May to discuss market conditions, deciding whether to extend the Vi­enna accord or amend it.

Two important challenges con­front the agreements: First, how quickly can the cuts reduce record-level commercial oil stocks. Inter­national oil companies stored more than 3 billion barrels of oil by 2016. There was an incremental sup­ply of 20 million bpd to the stocks. The cuts were supposed to stop the stocks from rising and even lower them, causing a possible strength to prices or at least stabilising them at a higher level of around $55-60 a barrel.

Second, how will the producers monitor the production cuts? OPEC has relied on secondary sources — energy media and consultant groups — to monitor production. OPEC has now established a committee of Algeria, Kuwait and Venezuela to observe the production levels of member countries. A larger commit­tee has been established to monitor non-OPEC production.

The establishment of committees to monitor production is a positive step to provide credibility to the ac­cords but reducing production and monitoring countries’ levels of pro­duction are difficult to undertake even in the best of times.

What are the signals that would provide market stability? The first has already been undertaken by Saudi Arabia. Saudi Energy Minister Khalid al-Falih said following the December 10th OPEC-non-OPEC ac­cord that Riyadh was willing to cut production further, if necessary, to stabilise the markets. This signal led prices to rise and stabilise at a range of $55-58 per barrel, rather than $50- 55 per barrel. The second signal will be how quickly global stocks de­cline.