Westwood Insight: OPEC - Holding Firm, For Now
OPEC's decision at the 30 November Vienna meeting to extend production cuts through the end of 2018 was widely expected. What was less expected was the relative ease with which the extension was agreed, including Nigeria and Libya — previously exempt — accepting soft caps on their output for the first time.
The market response was muted. Brent briefly touched $64 before settling back toward $62. Traders, it seems, had priced in the extension weeks earlier.
Compliance holds — mostly
OPEC compliance with the agreed cuts has been surprisingly strong, running at roughly 115% on an aggregate basis through October 2017. Saudi Arabia has done the heavy lifting, cutting well beyond its committed share and holding output below 10 million barrels per day for most of the year.
Compliance is less impressive when you look beneath the headline. Iraq has consistently underdelivered, producing 100,000-150,000 b/d above its target in most months. The UAE has been inconsistent. And both Libya and Nigeria increased output by a combined 400,000 b/d over the course of 2017, partially offsetting the cuts elsewhere. The inclusion of both countries in the extended agreement is designed to close this loophole, though enforcement will be tricky.
The shale complication
Every barrel OPEC withholds from the market creates space for US shale producers to fill. US crude output hit 9.7 million b/d in November, up from 8.8 million at the start of 2017. The EIA projects output will exceed 10 million b/d by mid-2018, a level not seen since the early 1970s.
The awkward reality for OPEC is that the cuts are working — in the sense that global inventories are drawing down — but the price signal they're sending is simultaneously accelerating the very supply growth that undermines their market share. Every month that Brent stays above $60, another few dozen Permian wells become economical that wouldn't have been drilled at $50.
How long can this hold?
DW expects OPEC compliance to gradually erode through 2018. By the June review meeting, several member states will be pushing for relaxation, particularly if Brent sustains above $65. Saudi Arabia's willingness to carry the burden depends heavily on the Aramco IPO timeline — the Kingdom has every incentive to support higher prices at least until that process is resolved.
The base case: cuts hold nominally through 2018, actual compliance drifts toward 85-90%, and the oil price stays range-bound between $58 and $68. A messy equilibrium, but OPEC has learned to live with those.
Stuart Murphy, Senior Analyst, Douglas-Westwood