OPEC's work to cut oil production
may be finally starting to pay off. The oil-exporting organization and its allies have slashed output by about 1.6 million barrels per day (bpd) since the beginning of the year, helping to lift oil prices. And key producers, such as Saudi Arabia and Russia, have already indicated that they may push to extend the production-cut deal beyond its expiration date in March 2018. But the organization's Joint Ministerial Monitoring Committee (JMMC), meeting in Vienna, declined to make a recommendation on the cuts. Kuwaiti Oil Minister Essam al-Marzouq said that there was no need to decide now that the market was "well on its way toward rebalancing."
Predictions Not Panning Out
Although oil prices were pushed down earlier this year as Libyan, Nigerian, Brazilian, U.S. and other producers saw their oil production rise, those drops may be nearing an end. Libya's oil production, which rose from 390,000 bpd in 2016 to 1,003,000 bpd in April 2017, has crested. Technical and political disputes now hamper any further increases, and production slipped to 890,000 bpd in August. In Nigeria, production rose from about 1.511 million bpd in the first three months of this year to 1.861 million bpd in August. But its production is also beginning to stall because of similar difficulties.
The production increase by Nigeria and Libya totaled 960,000 bpd, or roughly 60 percent of the cut that OPEC and non-OPEC members had agreed to. A large majority of this increase took place between April and July, exacerbating market concerns about oversupply, just as the United States was boosting tight oil production, principally in the Wolfcamp, Bone Spring and Spraberry shales of the Permian Basin. Tight oil, also known as shale oil or light tight oil, is the crude contained in shale or tight sandstone formations.
But concerns about oversupply may have been distorted by inaccurate early production estimates. Those estimates — released during June and July — suggested that U.S. tight oil production increased by 450,000 bpd between December 2016 and June 2017, underpinning a total estimated increase in U.S. oil production of 554,000 bpd. However, once reported production levels were released two months later, U.S. production had risen by just 326,000 bpd, and the increase had stalled, with production rising by only 27,000 bpd between February and June. The large increases projected in the short-term energy outlook by the U.S. Energy Information Administration (EIA) have not materialized. This week Continental Resources Chairman Harold Hamm criticized the EIA estimates for growth potential, saying that they distorted market perceptions of the underlying reality. Still, oil market watchers are now realizing that U.S. tight oil increases may not show up as quickly as had been projected.
At the same time, Saudi Arabia has continued to reduce its oil exports as it curtails excess inventories. The EIA has also increased its estimates of the growth of global oil demand over the past few months. Global crude inventories continue to decline and could possibly reach five-year-average price levels — the stated goal of Saudi Arabia — next year without an extension. All this news has supported oil price increases in the last month with the benchmark price for Brent light sweet crude rising above $56 per barrel for much of the past week — a nearly 30 percent increase since it bottomed out in late June at slightly under $44 per barrel. Although the JMMC didn't recommend extending the cuts, even Kuwaiti Oil Minister Essam al-Marzouq said that there was no need to extend cuts right now as it was quite clear that the market was "well on its way toward rebalancing," which is a very different message than that heard at the previous meeting of the JMMC in July.
Riyadh, Moscow Hang Tough
Despite this optimism, Saudi Arabia, Russia and others are going to be adamant that an extension be considered for two reasons. First, Saudi Arabia and Russia need to ensure that the oil market continues to rebalance, which will aid their economic stability
. Russia is in a fragile position with a localized banking crisis and other economic concerns. President Vladimir Putin's popularity has waned, and the Kremlin wants to ensure stability ahead of presidential elections in March-April 2018 and shortly after.
In Saudi Arabia, rumors swirl that King Salman's abdication is imminent
and that Crown Prince Mohammed bin Salman will soon ascend the throne. Bin Salman has been the architect of the country's reform efforts, which have struggled in the last few months to meet goals on its Saudi employment programs and on non-oil revenue. The country is even reportedly considering slashing subsidies for gasoline and other energy products later this year. Saudi Arabia's economic reforms remain in development, and the initial public offering (IPO) of 5 percent of Saudi Arabian Oil Co. — the state oil company — is expected to support a lot of its growth. That IPO, slated for 2018, could be pushed to 2019. In order for it to be successful, the oil market needs to be stable.
Saudi Arabia, Russia and others are aware that their production cuts are not going to increase oil prices much beyond where they are now. While the resiliency of U.S. tight oil production has not been as high as initially thought, at $60 per barrel, production increases outside the Permian Basin will become more likely as those fields become more attractive. From the point of view of Moscow and Riyadh, the intent of the cuts is to reduce oil inventories and to prevent another price downturn or collapse rather than to increase prices more. Neither country can afford a collapse in 2018, so when Riyadh and Moscow borrow European Central Bank President Mario Draghi's "whatever it takes" phrase, they mean it.
Second, Moscow and Riyadh want to ensure that oil market participants do not speculate on the demise of the production-cuts deal. An enormous amount of oil production has been slashed. This means that OPEC and non-OPEC countries will face the key challenges of whether — and how — to exit the deal. If not done in an orderly fashion, the onslaught of supplies would send prices tumbling, resulting in the scenario that all the producers wish to avoid. By keeping the option of extending cuts on the table, Riyadh and Moscow are trying to limit any speculation that the deal is ending soon.
For major oil producers, the key question in 2018 will be: what's next? Inventories may be declining, but the concerns of overwhelming the market quickly are likely to force the debate on an exit strategy. This will not be an easy negotiation, because many smaller countries will demand to reduce commitments more quickly. It is likely that Riyadh and Moscow will need to give priority to the exit of other countries over their own because of the scale of the production cuts. Another option, and one that will likely entertain a lot of debate, is whether OPEC — even in harmony with Russia and other non-OPEC producers — will just use the current production levels with the cuts as the basis for re-introducing individual OPEC quotas. Individual quotas have not existed since the global financial crisis when they were scrapped for a bloc-wide quota. Nonetheless, while the market is improving, that recovery is only driving new and important questions for major oil producers. And the debate over the new concerns is likely to pick up before the next OPEC meeting in Vienna on Nov 30.