With the oil markets rattled after sharp losses in recent days, the IEA is telling everyone to slow down and stay the course, as the OPEC cuts will take time to work. In its latest Oil Market Report, the Paris-based energy agency said the “market needs time for the full impact of the big supply cuts under the output reduction agreements to be felt.”
The IEA did not make any significant alterations to its forecast for the year, still predicting a supply deficit in the first half of the year. Demand growth of 1.4 million barrels per day will continue to eat away at the surplus, providing sounder footing beneath oil prices.
But even as it reiterated its projection, the IEA itself sounded a bit more worried than in recent months. “For those looking for a re-balancing of the oil market the message is that they should be patient, and hold their nerve. In the meantime, the volatility that suddenly broke out last week will probably recur, as the IEA has regularly warned,” the agency said in its report. It also admitted that “the market is still dealing with a vast amount of past supply,” which is taking a long time to clear. Instead of panicking, let’s see this thing through, the IEA appeared to be saying.
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That is all well and good, but a stay-the-course approach only really works if OPEC continues its high level of compliance with its production cuts, and arguably also decides to extend those cuts through the end of the year.
But new data could throw cold water on those hopes. In OPEC’s latest Oil Market Report, it appears that Saudi Arabia might have actually increased its oil production between January and February, undermining claims that it had cut deeply below its promised target. As part of the OPEC deal, Saudi Arabia pledged to cut output down to 10.058 million barrels per day, a cut of roughly 500,000 barrels per day from October levels. By January, Saudi officials boasted that they had cut much more than they were required to, reducing output below 9.8 mb/d, while also offering hints that more cuts could be forthcoming.
However, Saudi Arabia apparently told OPEC that it ramped production back up by 263,000 bpd in February, taking output to 10.011 mb/d. To be clear, it is still adhering to its promised target, but because Saudi officials in recent weeks have hyped up their extraordinary unilateral sacrifice by cutting more than promised, the data suggests they are not cutting as much as once thought. Saudi officials downplayed the numbers, saying the "difference between what the market observes as production, and the actual supply levels in any given month, is due to operational factors that are influenced by storage adjustments and other month to month variables." Related: New Oil Price War Looms As The OPEC Deal Falls Short
But assuming this is not some data anomaly, what’s the significance of the rise in output? Why would Saudi Arabia ramp production back up in February after boasting about shouldering much of the group’s burden? First off, perhaps the Saudis are starting to lose a bit of faith in the rest of the participants in the deal, with a handful of OPEC and non-OPEC countries proving a bit slow to live up to their commitments. “The Saudis are once again showing their stern face, as they did in the days before the OPEC meeting, and trying to get the laggards to live up to their promises,” Helima Croft, head of commodity strategy at RBC Capital Markets LLC, told Bloomberg in an interview.
Second, perhaps Saudi Arabia is growing wary of the rapid comeback in U.S. shale. This is speculation of course, but it comes after Saudi energy minister Khalid al-Falih warned the U.S. shale industry last week in Houston that OPEC would not “bear the burden of free riders,” nor would it “underwrite the investments of others at our own expense.”
Regardless, there could be fallout from the rise in production. Saudi Arabia’s about face, boosting output after pushing a narrative of sharp reductions and a historic level of compliance, could undermine the willingness of other members to make production cuts. OPEC has always struggled with compliance, given that every member has an incentive to cheat. And the more the deal drags on, the more pressure there will be for members to abandon their commitments. That is especially true if oil prices fail to rise. After all, what is the point of cutting and losing market share if oil prices are not rising? Related: EIA And OPEC Send Oil Prices Tumbling
To reiterate, Saudi Arabia is not cheating – its output is still below its target. But the problem of compliance will grow worse if it appears that the resolve of Saudi Arabia – the linchpin of the deal, the largest contributor of the cuts, and the largest booster of the deal – starts to waver. If oil prices continue to lose ground, dipping down towards the mid-$40s, and cracks in Saudi Arabia’s commitment begin to surface, then other countries could decide to go it alone. At the very least, keeping everyone on board for a six-month extension would become exceedingly difficult.
Saudi Arabia’s surprise uptick in production will also further deflate market sentiment, already reeling in recent days because of the enormous buildup in U.S. crude oil inventories this year. For now, the oil market is pinning its hopes on what appears to be a more bullish figure from the weekly inventory data in the U.S., with private sector estimates showing a drawdown in crude stocks. Oil prices moved up on the news.
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But that will offer very little solace to the oil market if the impressive OPEC compliance rate starts to wobble.
By Nick Cunningham of Oilprice.com
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