The countries of OPEC, once all-powerful in determining oil prices, besieged by infighting – have agreed to their first production freeze in eight years. After many aborted attempts to implement a supply cut, many were skeptical that this latest attempt would succeed. It certainly was a rocky road getting here; the cut was informally agreed in September, and very public outcries by Iran, Iraq, Libya and Nigeria cast doubt on OPEC’s ability to whip its members in line.
After the classic display of Game Theory over the past two yeas, OPEC will reduce its output by 1.2 mb/d by January, confirming OPEC’s intention to stick to the 32.5 mb/d level agreed in Algiers two months ago. More importantly, the agreement extends beyond OPEC, with non-OPEC nations also agreeing to implement cuts, including Russia.
The test of this will be actually implementing it, which is the harder portion of the equation. Nigeria and Libya are exempted from the cuts as they recover from infrastructure damage inflicted earlier this year, but Saudi Arabia, Iran and Iraq have all been given quotas. In particular, Iran has put aside its squabbling with Saudi Arabia to agree to capping its output at 3.8 mb/d, while Saudi Arabia will reduce its production by almost 500 kb/d, the UAE by 140 kb/d and Kuwait by 130 kb/d. Indonesia has requested a suspension of its OPEC membership (only two years after being re-admitted) as production cuts conflict with the country’s urgent need to raise its crude production. Saudi Arabia and its Gulf allies have generally stuck to their quotas in the past, but many other OPEC members haven’t. This will be a constant problem, which may undermine the whole integrity of the agreement.
But thus far the market seems to think OPEC will stick to the plan, sending Brent and WTI crude above the US$50/b mark, the highest since the OPEC Algiers plan was first announced.
Crucially, the plan also includes participation from non-OPEC members. Exactly what this entails is unknown beyond a vague statement that non-OPEC members are expected to reduce production by some 600 kb/d, with Russia decreasing by 300 kb/d (‘conditional to technical ability’, of course). These cuts are non-binding, and again, the harder part after herding the cats together to agree is actually implementing the plan. OPEC’s talks with non-OPEC producers continues on December 9, and meeting again next May to monitor progress. Analysts at Deutsche Bank said the deal isn’t enough to change the oil market outlook. The bank is skeptical that the full reduction will be realized, especially from non-OPEC countries. Analysts said oil traders would watch the agreement warily in the coming weeks.
Rising oil prices in the wake of OPEC’s production cut could hit demand from Asia’s emerging energy consumers, where weakening currencies have already led to higher prices. Since oil is priced in dollars, it makes crude more expensive in local currencies that have weakened against the greenback. China and India, the world’s second- and third-largest oil consumers after the U.S., have each seen declines in their currencies versus the U.S. dollar in recent weeks. However the beleaguered Asian oil industry could benefit from OPEC’s decision to cut production
But we are certainly in more positive territory than we were yesterday. OPEC has agreed to a supply freeze. Most would have dismissed this as a Yeti sighting, but it actually has happened. The nuts and bolts of enforcing it will now begin, and there are plenty of ways this house of cards could tumble down, but as it stands now, 2017 looks to be a better year for oil than 2016. Which can only be a good thing for you and me.
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Headline crude prices for the week beginning 14 October 2019 – Brent: US$59/b; WTI: US$53/b
Headlines of the week
Amid ongoing political unrest, Ecuador has chosen to withdraw from OPEC in January 2020. Citing a need to boost oil revenues by being ‘honest about its ability to endure further cuts’, Ecuador is prioritising crude production and welcoming new oil investment (free from production constraints) as President Lenin Moreno pursues more market-friendly economic policies. But his decisions have caused unrest; the removal of fuel subsidies – which effectively double domestic fuel prices – have triggered an ongoing widespread protests after 40 years of low prices. To balance its fiscal books, Ecuador’s priorities have changed.
The departure is symbolic. Ecuador’s production amounts to some 540,000 b/d of crude oil. It has historically exceeded its allocated quota within the wider OPEC supply deal, but given its smaller volumes, does not have a major impact on OPEC’s total output. The divorce is also not acrimonious, with Ecuador promising to continue supporting OPEC’s efforts to stabilise the oil market where it can.
This isn’t the first time, or the last time, that a country will quit OPEC. Ecuador itself has already done so once, withdrawing in December 1992. Back then, Quito cited fiscal problems, balking at the high membership fee – US$2 million per year – and that it needed to prioritise increasing production over output discipline. Ecuador rejoined in October 2007. Similar circumstances over supply constraints also prompted Gabon to withdraw in January 1995, returning only in July 2016. The likelihood of Ecuador returning is high, given this history, but there are also two OPEC members that have departed seemingly permanently.
The first is Indonesia, which exited OPEC in 2008 after 46 years of membership. Chronic mismanagement of its upstream resources had led Indonesia to become a net importer of crude oil since the early 2000s and therefore unable to meet its production quota. Indonesia did rejoin OPEC briefly in January 2016 after managing to (slightly) improve its crude balance, but was forced to withdraw once again in December 2016 when OPEC began requesting more comprehensive production cuts to stabilise prices. But while Indonesia may return, Qatar is likely gone permanently. Officially, Qatar exited OPEC in January 2019 after 48 years of continuous membership to focus on natural gas production, which dwarfs its crude output. Unofficially, geopolitical tensions between Qatar and Saudi Arabia – which has resulted in an ongoing blockade and boycott – contributed to the split.
The exit of Ecuador will not make much material difference to OPEC’s current goal of controlling supply to stabilise prices. With Saudi production back at full capacity – and showing the willingness to turn its taps on or off to control the market – gains in Ecuador’s crude production can be offset elsewhere. What matters is optics. The exit leaves the impression that OPEC’s power is weakening, limiting its ability to influence the market by controlling supply. There are also ongoing tensions brewing within OPEC, specifically between Iran and Saudi Arabia. The continued implosion of the Venezuelan economy is also an issue. OPEC will survive the exit of Ecuador; but if Iran or Venezuela choose to go, then it will face a full-blown existential crisis.
Current OPEC membership:
U.S. crude oil production in the U.S. Federal Gulf of Mexico (GOM) averaged 1.8 million barrels per day (b/d) in 2018, setting a new annual record. The U.S. Energy Information Administration (EIA) expects oil production in the GOM to set new production records in 2019 and in 2020, even after accounting for shut-ins related to Hurricane Barry in July 2019 and including forecasted adjustments for hurricane-related shut-ins for the remainder of 2019 and for 2020.
Based on EIA’s latest Short-Term Energy Outlook’s (STEO) expected production levels at new and existing fields, annual crude oil production in the GOM will increase to an average of 1.9 million b/d in 2019 and 2.0 million b/d in 2020. However, even with this level of growth, projected GOM crude oil production will account for a smaller share of the U.S. total. EIA expects the GOM to account for 15% of total U.S. crude oil production in 2019 and in 2020, compared with 23% of total U.S. crude oil production in 2011, as onshore production growth continues to outpace offshore production growth.
In 2019, crude oil production in the GOM fell from 1.9 million b/d in June to 1.6 million b/d in July because some production platforms were evacuated in anticipation of Hurricane Barry. This disruption was resolved relatively quickly, and no disruptions caused by Hurricane Barry remain. Although final data are not yet available, EIA estimates GOM crude oil production reached 2.0 million b/d in August 2019.
Producers expect eight new projects to come online in 2019 and four more in 2020. EIA expects these projects to contribute about 44,000 b/d in 2019 and about 190,000 b/d in 2020 as projects ramp up production. Uncertainties in oil markets affect long-term planning and operations in the GOM, and the timelines of future projects may change accordingly.
Source: Rystad Energy
Because of the amount of time needed to discover and develop large offshore projects, oil production in the GOM is less sensitive to short-term oil price movements than onshore production in the Lower 48 states. In 2015 and early 2016, decreasing profit margins and reduced expectations for a quick oil price recovery prompted many GOM operators to reconsider future exploration spending and to restructure or delay drilling rig contracts, causing average monthly rig counts to decline through 2018.
Crude oil price increases in 2017 and 2018 relative to lows in 2015 and 2016 have not yet had a significant effect on operations in the GOM, but they have the potential to contribute to increasing rig counts and field discoveries in the coming years. Unlike onshore operations, falling rig counts do not affect current production levels, but instead they affect the discovery of future fields and the start-up of new projects.