OPEC Deal Not Sufficient for Draining Inventories – 1/23/17

Comments from Saudi Energy Minister Khalid Al-Falih are raises concerns that OPEC’s biggest oil producer will abandon output cuts before prices make significant gains.

“We don’t think it’s necessary, given the level of compliance we have seen and given the expectations of demand,” Al-Falih said recently. “The re-balancing which started slowly in 2016 will have its full impact by the first half. Of course, there are many variables that can come into play between now and June, and at that time we will be able to reassess.”

OPEC’s decision to cut output reversed a two-year policy to maximize sales and protect market share from high cost shale drillers in the U.S — a strategy that had contributed to the worldwide glut of crude oil. The group, together with 11 other countries, came to an agreement on reducing supply by about 1.8 million barrels a day with cuts in effect from January to June.

Al-Falih said he was confident of the deal’s success and that OPEC will stop intervening in the market once global crude inventories return to their five-year average.

Yet, analysts from Bloomberg see the current agreement as a half-measure when it comes to clearing the global glut. According to their analysis, ending the deal by mid-year as planned and restoring production could mean a return to a building oil inventories. OPEC said draining bloated stockpiles was the main aim of the supply curbs.

If they extend the deal for six months beyond its scheduled expiry in June, that surplus will be entirely eliminated by the end of the year, according to Bloomberg calculations based on IEA data. If they don’t prolong the cuts and instead restore output to previous levels, about two-thirds of that glut will remain in place.

Oil prices rose 20% in the month after OPEC agreed to cut output. Since then, they’ve slipped almost 5% as traders, eyeing U.S. shale production, await proof that the deal will work. Many remember how Russia broke its pledge to cutback in 2008, while other members of group also failed to fully implement the agreement.

“OPEC is going to yet again over-promise and under-deliver,” said Eugen Weinberg, head of commodities research at Commerzbank AG, in a Bloomberg TV interview. “We are going to get cheating from OPEC; we’re going to get false information.”

Other analysts say OPEC has little choice but to go forward, given the economic damage the price rout has brought on the group’s members.

“The reward is so big that I believe they will be more respectful than they have been in the past,” said Paolo Scaroni, vice chairman of NM Rothschild & Sons Ltd. “They are so desperate that they will do whatever they can to do it — even sacrifices.”

The figures may not be useful, as exports will for some time still reflect production levels from before the agreement, said Ed Morse, head of commodities research at Citigroup Inc.

Based on the initial data, the committee will be able to report compliance of as much as 60%, said Morse. The best rate attained during its 2008 agreement was 70%, according to Hasan Qabazard, OPEC’s former head of research.

“They’re looking for 80% compliance,” said Morse. “50 to 60% compliance in the first few weeks is pretty good. If you just add up the Gulf countries and Russia today, that’s a very constructive contribution.”

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