The oil markets were boosted overnight by the news from the International Energy Agency (IEA) that compliance to the schedule of cuts agreed by OPEC to start on January 1st this year was at record levels. Those unfamiliar with the workings of OPEC may be surprised to learn that those “record levels” are only 90%. Surely, you might think, compliance with something like that, agreed by all the parties to the cut, should be 100%. You may also think that cutting output by “only” 2% would mean that everyone could do their part. If either of these things occurred to you though, you are unfamiliar with OPEC’s history. The last round of cuts, back in 1980 for example, saw only 80% compliance and 2% is the largest reduction ever called for.
As always with OPEC, however, the devil here is in the detail. Overall compliance with cuts is one thing, but what will decide the future of this agreement is the distribution of those output restrictions, and when that is considered the future is not quite as rosy as the market reaction this morning might suggest. Venezuela, for example, who were among the first countries to push for OPEC action have achieved a whopping 18% compliance with their scheduled cuts.
Venezuela, of course is a drop in the bucket in terms of global oil production, and if you could administer truth serum to the other OPEC oil ministers I doubt that any of them really expected the Venezuelans to conform to the agreement. That said though, the problem is that 18% compliance from anywhere gives others the excuse to pull out whenever they feel like it. If one of the Saudis’ geopolitical rivals makes that decision or even begins to drift towards lower compliance then the deal is off.
In addition at least some of the OPEC cuts have been offset by increases elsewhere. In addition to greater production in the U.S. that we suspect based on rig count and inventory numbers there is hard evidence that Libya and Nigeria, who were excluded from the original schedule of cuts, have also stepped up production. Compliance among the non-OPEC signatories to the deal is also somewhat wobbly, with the Russia led eleven reaching about 50% of their goal. The Saudis are used to doing the heavy lifting when it comes to OPEC cuts, but the situation now, with budget problems emerging there, is a bit different. It may be that they will cover for others again but this time around it is no sure thing.
In reality the more impactful part of the IEA report overnight was the fact that they increased global demand forecasts for both this year and next. That forecast may be accurate or it may not but the forecast itself is an important metric for traders. We have had a situation where supply outstrips demand for some time and even with OPEC’s 2% cut demand increases are needed to make a meaningful dent in existing global stockpiles.
Given that the fact that oil prices rose only one or two percentage points on the news and seem to be giving back some of that in early trading today is a better indicator than most of the headlines of what traders feel about OPEC’s news. There may well be record compliance to a record cut in production but, when all of the details are broken out, this still looks like a fragile agreement.