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OPEC needs to rethink its production cutting strategy
May 25, 2017, 9:00 am
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The decision by several Organization of Petroleum Exporting Countries (OPEC) and NOPEC (non-OPEC) states to cut oil production from January 2017, has had a tangible effect on global oil markets. Oil inventories worldwide have fallen on average by about 1.8 million barrels per day (mmb/d) since November 2016.

However, industry analysts say that though oil inventories have fallen, the global oil glut is proving to be more tenacious than expected. Petro-states are realizing that balancing supply and demand is a much more formidable challenge than just turning off the oil valves and waiting for the dollars to roll in.

Market vagaries and political vacillations are having a much larger than predicted influence on oil prices. In what is perhaps an admission that production cuts have so far failed to soak up the excess oil sloshing in global markets, Saudi Arabia and Russia, two of the world’s top oil producers, agreed last week to extend their production cuts through to March of next year.

In a joint statement, Saudi Energy Minister Khalid Al-Falih and Russian Energy Minister Alexander Novak pledged “to do whatever it takes to achieve…market stability, predictability and sustainable development.”

Ahead of the crucial OPEC meeting in Vienna on 25 May, a realistic assessment of the impact of production cuts in place since January, reveal two main factors behind the oil glut and Brent prices remaining in the mid $50 range since the start of the year. First, much of the OPEC cuts since January have been borne by Saudi Arabia, and the other two GCC oil surplus states of Kuwait and the UAE. Also, among NOPEC nations, with the exception of Russia, most others have not lived up to their pledged cuts.

But there are limits to how much Saudi Arabia and its GCC allies, as well as Russia, can dial back production to shore up prices as their economies continue to bear the pain of production cuts. Riyadh has already cut down its output by 500,000 barrels per day, which is more than any other OPEC member.

Making matters worse, Iran, which is just emerging from years of sanctions on its oil exports is reluctant to deliver any significant contribution to the pledged OPEC production cuts. On the contrary, the Islamic Republic is ramping up production to regain its lost market share. Also, countering the production cuts by OPEC, are other member countries such as Nigeria, Iraq and Libya, where production had in recent years been besieged by conflicts. These countries have now begun to increase their production.

The second factor behind why, despite the best efforts by petro-states, oil continues to trade in the relatively low range is that their production cuts have galvanized dormant shale producers in the United States to revive production.

OPEC has been trying to choke or at least contain US oil boom for the last three years. By flooding the market from late 2014 on, the cartel hoped to drive oil prices so low that shale wells would be uneconomic.

Though the strategy was not a total failure — some US shale projects were shuttered as producers took a sabbatical while prices were low. However, ever since oil prices rose over the $50 mark, shale producers have been coming back in droves. Overall the US shale oil boom has proven a lot more resilient than anyone in OPEC or NOPEC expected.
Even as oil prices languished last year, US oil production only fell by about 800,000 barrels a day — but then quickly bounced back this year to more than 9 million barrels a day, even though crude prices are about the same.

And the US oil and gas rig count — another indicator of a country’s total production — rose again in May to nearly double what it was a year ago. Energy analysts believe that due to production and efficiency breakthroughs, shale can easily stay competitive even with oil as low as $45 a barrel, which means OPEC may have to come up with a Plan B or even a Plan C at their meeting this weekend in Vienna.

 

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