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Can OPEC Enforce A Non-OPEC Cut?

Oil rig misty

“This is shock and awe by Saudi Arabia” is how one analyst summed up the developments in the oil sector at the end of last week.

Mere minutes, seconds really, after Russia and several non-OPEC members agreed a deal that would reduce oil production, Saudi's oil minister Khalid al-Falih said, “I can tell you with absolute certainty that effective Jan 1, we're going to cut and cut substantially to be below the level that we have committed to on Nov 30th.”

Yasser Elguindi with Medley Global Advisors told Bloomberg.com, “The deal speaks volumes about the Saudi commitment to rebalance the market. No-one is talking any more about $30 a barrel oil.”

It turns out al-Falih and Novak have been working on this deal for nearly a year, and have met many times secretly, to find the way through.

Having seen previous efforts to rebalance the market falling squarely upon its own shoulders, Saudi had long campaigned for equal short-term pain to be shared among those who sought long-term gain. Despite some uncertainty just before the meeting with cynical observers questioning why non-OPEC would choose to do anything except sit back and enjoy the spoils, the deal was done.

For the first time since 2001 both OPEC and non-OPEC will curtail their oil production, focussing on driving prices upwards, supporting investment and reducing volatility. The agreed 558,000 bpd is not quite the 600,000 initially targeted but, according to the International Energy Agency, is equal to the estimated increase in demand from both India and China.

Russia is to cut 300,000 bpd. Its Energy Minister Alexander Novak said that it would not happen overnight, but within six months. How fair the quota cuts are is uncertain. Russia is reducing its share from the highest monthly production it ever achieved – 11.247m in October 2016. While Mexico is the only one to confirm its share will come from 'managed natural decline' (allowing a production drop through an unavoidable consequence of ageing fields) it's expected others such as Azerbaijan will do likewise. Related: Stormy Seas Ahead For Oil Markets

How good could it get? Who knows? It depends on the commitment to the deal. Gary Ross, founder of Pira Energy told Reuters.com that a price of $60 per barrel would be optimal as above that could make people greedy again. “They are all enjoying higher prices and compliance tends to be good in the early stages. But then as prices continue to rise, compliance will erode.” Not for OPEC the rallying cry of d'Artagnan and his moustachioed comrades.

To make their point, people will point back to 2001, when Moscow agreed a deal to cut oil but increased output instead. Things have changed considerably since then, a far cry from the early days of President Putin who had limited power in an industry split between oligarchs. Now it is owned largely by the Kremlin, and Putin.. Well, you know.

The most obvious threat remains US shale drilling. OPEC's decision in 2014 to go hell for leather and face down American producers left their own coffers bare and created a leaner, meaner machine. It is now possible to pump crude in North Dakota for the same price paid by Iran and Iraq. A resurgence in oil prices could encourage more drilling, and trump OPEC after all.

By Precise Consultants

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