On March 25-26 the monitoring committee for the OPEC-non-OPEC oil production agreement will meet in Kuwait. This meeting comes amidst recent volatility and a drop in oil prices to below $50/barrel for WTI for the first time in 2017. The five-nation committee’s evaluation will play a role in determining whether the production quotas should be continued for an additional six months when OPEC meets at the end of May.
The committee will likely report that the production cuts have been successful so far, that OPEC and non-OPEC compliance is good but could be improved—particularly from non-OPEC countries—and that all parties are optimistic. The committee will discuss whether the deal should be extended and may make a recommendation to OPEC.
Investors, however, should not be fooled into thinking that optimistic language is an indication that OPEC will extend the production cuts. Any extension of the agreement depends largely on what Saudi Arabia wants. Saudi Arabia’s decision will likely hinge on whether it believes other countries are contributing sufficiently to the cuts and performing “up to expectations.”
Investors should therefore consider whether the production cuts made by other producers are significant. According to Platts, differences in methodology and data collection have made it tricky to determine overall compliance rates. For example, depending on which countries are included in the accounting, compliance could range anywhere from 72% to 111%. (100% would mean perfect compliance, and a score better than that would be that the countries decreased production more than the agreement required).
Some countries, like Iraq and the UAE, have not fully implemented their assigned production cuts. When analyzing production cut numbers, it is important to consider that the agreement called for cuts from each country to average the designated number over the course of six months. Therefore, an off month does not make a country in breach of the agreement, but it means that country is not on pace to comply at the end of the full agreement term.
For non-OPEC countries, the current compliance rate is in the 40%-66% range, depending on the methodology. Russia’s rate of production has been the most concerning. At the end of February, Russia had only cut 120,000 bpd of its 300,000 bpd commitment. As of March 19, however, Russia announced that it had reduced production by an additional 161,000 bpd. Russia is currently the largest oil producer in the world, averaging just over 11 million bpd, although Saudi Arabia has the largest spare capacity – a reported 12.5 million bpd.
In January, as a show of good faith, the Saudis cut more than their quota called for. This helped OPEC’s overall compliance rate while allowing other countries some breathing room to implement cuts more gradually and helped push oil prices higher. However, in February the Saudis increased production—though still falling within their quota of 10.011 million bpd. This announcement contributed to the recent decline in oil prices. Though the Saudis specified that they were not exporting this extra production but instead using it to replenish depleted stores, the signal it sends to other producers is clear.
Saudi Arabia does not want to bear the brunt of the cuts on its own, and it appears adamant that it can, and will, use its significant spare capacity to pressure its fellow producers. With this spare capacity it can threaten to further overproduce which would lower the price of oil yet more and hurt all of the producers—though Saudi Arabia believes it is in the best financial position to withstand the pain.
Last week, the Saudi oil minister said in an interview that OPEC would look at the following conditions when determining whether the cuts should be extended:
- Whether global crude stock piles are above the 5 year average (which they almost certainly will be)
- If markets are not confident in outlook, and
- If companies and investors are not secure in the health of the global oil industry
All of these signals would appear to point towards an extension of the deal. Separately, however, the Saudi oil minister admonished producing countries and said that the Saudis would not continue to shoulder the bulk of the cuts while some participants “have not lived up to expectations.” He said, “Saudi Arabia will not allow itself to be used by others" and that the agreement is for the benefit of all.
The Saudis are clearly prepared to use the threat of a refusal to extend the current deal when it concludes at the end of June. Saudi Arabia hopes this will compel non-complying producers to fully meet their targets over the next three and a half months.
Saudi Arabia will extend the production cuts only if it believes that is in its best interest and only if the other nations are participating. The Saudis have been clear that they will not bear the costs of cutting production alone.