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Oil output cut deal effect to depend on many factors

Commentary Materials 14 December 2016 17:26 (UTC +04:00)
The effect of the oil output cut deal reached between OPEC and non-OPEC countries last week on the market will depend on several critical factors, Dr. Micha’el Tanchum, a fellow at the Energy Policies Research Center at Bilkent University, Ankara, Turkey, believes.
Oil output cut deal effect to depend on many factors

Baku, Azerbaijan, Oct. 14

By Elena Kosolapova – Trend:

The effect of the oil output cut deal reached between OPEC and non-OPEC countries last week on the market will depend on several critical factors, Dr. Micha’el Tanchum, a fellow at the Energy Policies Research Center at Bilkent University, Ankara, Turkey, believes.

“Right now, the markets are reacting to the news, rumors, and perceptions. Verifiable strict compliance over the long term is the key to a stable supply-demand balance,” Tanchum told Trend.

Last weekend OPEC and non-OPEC producers reached their first deal since 2001 to curtail oil output jointly and ease a global glut after more than two years of low prices. Non-OPEC oil producers such as Azerbaijan, Bahrain, Brunei, Equatorial Guinea, Kazakhstan, Malaysia, Mexico, Oman, Russia, Sudan, and South Sudan agreed to reduce output by 558,000 bpd starting from Jan. 1, 2017 for six months, extendable for another six months, to take into account prevailing market conditions and prospects.

Earlier OPEC agreed to slash the output by 1.2 million barrels per day from Jan. 1, with top exporter Saudi Arabia cutting as much as 486,000 bpd.

Tanchum noted that production cuts in some of the signatory countries will be more politically symbolic than anything else. For example Oman’s pledge of a production cut of 40,000 bpd is equivalent to one supertanker load per month. Mexico’s reduction pledge does not seems to be a real production cut but simply counting an expected natural decline in production as a supply cut, the analyst said adding that the same seems to hold true for Azerbaijan.

Russia’s reduction pledge likewise does not constitute a cut in current production, according to expert. He noted that Moscow planned to increase production in 2017 by 200,000 bpd to reach 11.48 million bpd, according the International Energy Agency.

“Moscow joined the OPEC reduction pledge by agreeing to freeze planned production increases. Through shrewd diplomacy, Russia is now receiving more revenue without cutting actual production,” Tanchum said.
The expert also noted that it will take many months before there is sufficiently reliable data to evaluate the actual level of compliance, adding that the rate of storage among the major producers is crucial to understanding whether and to what extent compliance is actually taking place.

“Russia and Iran are two key countries to watch carefully when determining the level of long term compliance,” he said.

Tanchum, who is also the author of the “A Post Sanctions Iran and the Eurasian Energy Architecture” published by the Atlantic Council, believes that Iran may choose to put a portion of its output into storage without really cutting production to appear to comply with the OPEC pledge. Russia may opt for this approach as well, especially as oil prices rise, according to the expert.

The expert also noted that storage may also have a self-reinforcing effect.

“If storage provides a false impression that there is strict production cut compliance, then buyers will also increase the level of storage. If widespread, such misjudgment would have disastrous consequences for the oil market,” he said.

Tanchum noted that if very large crude carriers rates increase, then it may be a sign that some producers may be putting oil into storage, cutting exports rather than actual production, whereas if very large crude carriers rates decline, it means less oil is being exported.

The analyst also noted that the anticipated reset in U.S.-Russia relations under Donald Trump, especially if sanctions enforcement is eased, may have unintended consequences on the OPEC reduction pledge as Saudi Arabia may re-assess its position, adding that perhaps even more consequential for Riyadh is the possibility of a rapid increase of drilling in the shale basins in the U.S. South west.

“If Saudi Arabia perceives the market not to be balancing it will intervene,” he said.

Tanchum expects that if the oil price climb well above $50, several producers will begin to less strictly comply with the production/export reductions, Riyadh will threaten to reduce the price through expanded production to reinforce compliance among backsliding nations.

“This would cause wobble in the market, but if managed well, the overall trend would be upward,” he said.
However, a ramp-up of U.S. shale production would likely cause a Saudi rethink and possibly Riyadh’s rapid intervention to reduce oil prices in order to stymy the development of additional U.S. shale production capacity, according to Tanchum.

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