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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Why The OPEC+ Deal Won’t Cut It

Now nearly a week removed from the OPEC+ agreement, confidence in the efficacy of the deal is becoming shaky.

Immediately after OPEC+ announced cuts of 1.2 million barrels per day (mb/d), a flurry of reports from oil analysts and investment banks congratulated the group on a job well done. After all, the 1.2 mb/d figure was larger than the market had anticipated.

However, reality is beginning to set in. First, the cuts might not be realized in January, despite the promise. Russia indicated that it was going to slow walk the cuts, phasing in an initial 50,000 to 60,000 bpd in reductions in January. This is significant because Russia is the main actor in the non-OPEC cohort. The non-OPEC group is expected to slash output by 400,000 bpd, but if Russia is only going to do its part gradually over the next few months, the non-OPEC cuts might not reach the promised levels anytime soon. Moreover, because there are no country-specific allotments, it will be hard to hold any producer accountable.

That undermines confidence in the deal. “Compared to early last week, the outcome was rather disappointing, the whole process wasn’t convincing, and it’s still uncertain whether they will actually cut,” ABN Amro senior energy economist Hans van Cleef told Bloomberg.

While oil traders are suddenly doubting the integrity of the deal, even if OPEC+ were to adhere to its promised cuts, it still might not be enough. That’s because there are other factors that could leave the market oversupplied. Cracks in the global economy are growing, demand is showing signs of strain, and supply continues to rise.

The EIA just issued its latest Short-Term Energy Outlook, and the agency still expects significant production growth from U.S. shale despite the downturn in prices. The EIA lowered its forecasted 2019 WTI prices by $10 per barrel from its previous report, yet it kept its supply forecast unchanged – it still thinks that U.S. oil production will rise from 10.9 mb/d in 2018 to 12.1 mb/d in 2019, despite the significant downward revision in prices. Related: Morgan Stanley Slashes Oil Price Forecast For 2019

In other words, U.S. shale production may not be slowed by the recent downturn in prices in any dramatic way, and at the same time, with its production cut agreement, OPEC+ reassured shale executives that it wouldn’t let prices fall any lower. “The US is not only the world’s largest oil producer at present, but will also remain the leading marginal producer in future,” Commerzbank said in a note.

According to Rystad Energy, OPEC+ would need to cut an additional 700,000 bpd in order to balance the market and bring Brent back up to $70 per barrel. “The  OPEC+ agreement predictably came up short of what Rystad Energy argued would be required to fully balance the market in 2019,” Bjornar Tonhaugen, Rystad Energy head of oil market research, said in a statement. “The agreed production cuts will not be enough to ensure sustained and immediate recovery in oil prices. The muted market reaction seen thus far comes as no surprise to us.”

Rystad says that the cuts agreed to in Vienna provide a “soft floor” beneath oil prices for now, and the group can still succeed if it extends the cuts through the end of 2019. The OPEC+ coalition is set to evaluate the progress of the cuts in April and might decide to extend the cuts in June if they feel the market needs more time. “Most likely, OPEC will be forced to conduct production management sporadically over the next few years, unless US shale supply grows even faster than we currently expect. OPEC members have their work cut out for them in the years to come,” Rystad’s Tonhaugen said. Related: 2019: A Pivotal Year For OPEC

The supply surplus could still be eliminated by unplanned outages. Libya just lost 400,000 bpd because of encroaching militias, according to the National Oil Corp. Venezuela and Iran are also set to continue to lose output, while Nigeria remains a risk. These events are impossible to predict, and they could quickly erase any supply overhang.

For now, though, the oil market is not convinced that the OPEC+ cuts will be sufficient to significantly increase oil prices, despite the initial euphoria surrounding the Vienna agreement.

By Nick Cunningham of Oilprice.com

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Leave a comment
  • David on December 12 2018 said:
    The EIA is mistaken if they think production will ramp up at this price range. All of the active basins have large basis blowouts right now. Bakken crude is trading at $33, and that's before transportation costs. Permian crude is in the same boat.

    Oil rig counts are dropping every week, and production plateaued in early November, and dropped last week.

    Low $50s may work in the sweet spots of the plays with historic basis and transportation costs, but we are triple those costs in the Permian currently, and double in the bakken, powder, etc.

    Companies are already filing for bankruptcy. This attack on the industry by Trump is a repeat of the Saudi attack in 2014-2016. It's not realized because the basis isn't talked about as much as it should be.

    Companies drilling in this environment are foolish or forced to to hold acreage or meet rig and midstream commitments.

    Expect further reductions in activity and production.

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