Are OPEC’s Hands Tied?

Brent is back above US$55 for the first time since February and WTI is hovering above US$50. The world should look like a better place for OPEC members and their partners who had to cut the economic equivalent of live flesh to make it happen. Yes, the latest global oil supply data has confirmed that the OPEC/non-OPEC Vienna Club has achieved its goal of cutting oil supply to more manageable levels. Yes, OPEC's output has fallen markedly. But no, this won't last long.

The IEA's latest Oil Market Report found that global crude oil supplies had fallen by 720,000 bpd in August, not just as a result of deliberate cuts, but also thanks to outages and field maintenance-mostly in non-OPEC producers. The agency also noted oil production in OPEC fell in August for the first time since March, while compliance with the cut deal improved to 82 percent, making the overall for the year-to-date adherence 86 percent.

The Vienna Group's compliance monitoring committee is meeting today to discuss the progress, and the oil ministers will probably have reason to pat each other on the back. They did it: oil supplies are down and prices are up. But that's just for now, and on this point, analysts seem to be unanimous. Higher summer demand in the northern hemisphere had a part to play in the oil supply decline, and that part was no small one. Production outages, most notably in Libya, also helped to drive global supply down.

Now summer season is over and demand will start falling. While the situation in Libya remains unstable and no accurate predictions can be made about further disruptions in oil production there, U.S. shale producers may start adding rigs once again, after a month or so of slowing. Other non-OPEC producers, for example in the North Sea, are also eyeing higher production going forward, which, according to the IEA, is bad news for OPEC and its partners as this higher output will exceed the demand growth rate next year.

OPEC, meanwhile, seems to be leaning further in the direction of another cut deal extension, doing exactly what several analysts said it shouldn't do. In fact, media recently quoted Iraq's Oil Minister as saying the cuts could even be deepened by 1 percent. It's understandable: when you put a lot of effort into something and you finally start seeing that it's working, you get additional motivation to continue doing this thing. In the case of OPEC, however, the "thing" might push it further into the corner that it put itself into with the cuts.

The more time passes, the higher the likelihood of another extension will become. As demand for crude wanes during the winter months, and in the absence of a supply disruption to prop up prices, prices are bound to start sliding downward. To arrest the slide, OPEC will need to either deepen or extend the cuts, or both. And OPEC, or at least some of its members, really will need to arrest the slide.

Related: U.S. Shale: Water Is the New Oil

Saudi Arabia is preparing for the IPO of giant Aramco. Keeping prices where they are is crucial for the valuation of the company on which the future of the country's economic diversification plan depends. Iraq, still bleeding cash, continues its fight with what remains of Islamic State, and is now facing the prospect of an independent Kurdistan, which is home to much of its oil. Venezuela in its entirety is in turmoil. Nigeria may or may not join the cut. Libya is not joining. Iran has plans to boost its oil production, which would compromise its participation in the deal.

In light of all this, analysts are already warning that failure to extend the cut beyond March 2018 will have a bearish effect on oil prices. OPEC's hands are pretty much tied, and the more time that passes, the tighter the tie will get.

By Irina Slav for Oilprice.com

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