Oil prices higher, steady as OPEC starts cutting production

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 the 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.
Walid Khadduri is an Iraqi writer on energy affairs based in Beirut.
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