OPEC must extend cuts to balance oil markets

OPEC decided that it would sacrifice some production to boost revenues through higher prices. That threw a lifeline to shale producers, and shale output has made a swift comeback since last year, oilprice.com reported.

Now, there is a growing expectation that OPEC can’t keep its cuts going. The OPEC/non-OPEC coalition had hoped that the market would have balanced after six months of cuts, but they were forced to agree to a nine-month extension through the end of the first quarter of 2018.

Few analysts, at this point, see the extension as sufficient, which raises the question of what happens after March of next year.

If OPEC really wants to balance the oil market, they would have to keep the cuts in place through 2018 at least. “They’re going to have to dig in for the long haul,” Neil Atkinson, head of the IEA’s oil markets and industry division, told Bloomberg TV.

Rebalancing is a stubborn process

The latest IEA report shows that OPEC’s current production at 32.8 mbd is higher than what the ‘call on OPEC’ — the implied demand for OPEC’s oil - for next year. In other words, the global market will be oversupplied next year given the current figures.

“If OPEC wants to keep oil prices in the $ 50s and hit $ 60, the organization will have to keep a lid on supply for several more years,” Sarah Emerson, energy principal at ESAI, told Bloomberg.

But, that just does not seem to be in the cards. The original six-month deal was relatively painless for a lot of OPEC members, save Saudi Arabia, who took on the lion’s share of the reductions.

Some of the participants, such as Venezuela and Mexico (a non-OPEC member), are suffering from declining production anyway. Countries like Russia tend to see their output dip in the winter, Iran Daily wrote.

Iraq and the UAE did not even fully comply with the deal. Iran was allowed to increase from its baseline, and Nigeria and Libya were exempted entirely.

However, the nine-month extension is a trickier proposition. Russia and Saudi Arabia see their production rise in summer months, which means the cuts are much more painful.

More importantly, many predicted that compliance would falter as time goes on. Recent data suggests the group's resolve is fraying — OPEC’s production in July rose to its highest point in 2017.

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Even if they can hold things together until March 2018, there are much lower odds that they will extend again.

“In the end, the markets are going to win and it’s going to be shale,” Citi’s Ed Morse told Bloomberg TV.

“The OPEC position, even with Russia, is really not sustainable over a long period of time. They are losing revenue by doing what they have done. Yes, they may be having a little bit higher revenue than they otherwise might have. But, you’ve got the prices up, you’ve got the US producers hedging through 2017 now, pretty much into 2018, and they can survive at a lower price. So they’re going to win.”

Morse also dismissed the recent concerns over the Permian, where companies like Pioneer Natural Resources reported higher gas-to-oil ratios in their production, suggesting wells are performing worse than expected. Morse said this is a ‘hiccup’ and a ‘temporary problem’, and that the Permian will grow “at a hefty rate this year and probably the same rate next year”.

If this turns out to be true and the US shale doesn’t miss a beat, then production will grow substantially, up to almost 10 mbd, according to EIA estimates. If that is the case, OPEC might throw in the towel next year and return to full production, at which point, prices could very well crash again.

While many will claim this is a ‘win’ for shale, this will be cold comfort to actual shale drillers that will once again have to suffer through another bout of low prices.

“We expect the total liquids balance to return to a more pronounced surplus over 2018, bringing with it a return to stock builds and a firm lid on prices,” JBC Energy wrote in a recent note.

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