OPEC ‘freeze’ starts to melt upon further examination

Source: Nathanial Gronewold, E&E reporter • Posted: Monday, October 3, 2016

Crude prices rallied strongly last week after news that members of the Organization of the Petroleum Exporting Countries (OPEC) reached a deal at their extraordinary meeting in Algiers, Algeria.

But that euphoria quickly ebbed as traders and analysts reconsidered the details of the agreement and the ongoing reality of the oil market, which remains oversupplied with crude oil.

OPEC went into the meeting determined to deliver an outcome that would reverberate in the press. Conference President Mohammed Bin Saleh Al-Sada, who is also minister of energy and industry for Qatar, pleaded with the member states to deliver some kind of agreement in his opening remarks.

“The market has changed since June, and our expectations about the rebalancing process have shifted,” he said. “It is evident that there is now a greater degree of urgency about ensuring the market returns to balance as quickly as possible.”

While OPEC suggested it would move quickly to cut its combined output by about 740,000 barrels of oil per day, the devil is in the details.

Current OPEC production is estimated at slightly above 33 million barrels a day. The actual agreement reached in Algiers would see OPEC member states aiming to keep production in a range of 32.5 million to 33 million barrels a day.

In other words, OPEC essentially returned to setting a targeted ceiling on its combined output, an aim abandoned at a regular meeting in December 2015. Analysts at Rystad Energy, a consulting firm, calls this deal the long-anticipated “freeze” on output that market observers have been speculating on for several months. And it’s not a very firm freeze at that.

“Based on our understanding, the deal includes exemptions for certain countries which have experienced production disruptions, including Nigeria and Libya,” Rystad oil markets analyst Bjørnar Tonhaugen wrote in a note. “The OPEC committee will likely propose country-specific targets/caps on the remaining members’ production at the Ordinary OPEC meeting on 30 November.”

OPEC itself says the range target is aimed at getting markets to draw down on the enormous volumes of crude in storage. As demand rises, should OPEC keep production in this range, the thinking is that storage will begin registering significant draws, lessening the global storage glut and encouraging higher crude prices, thereby aiding OPEC’s oil-export-dependent economies.

OPEC also reiterated a pledge to reach out to other major non-OPEC producers to further enable a rebalancing of global supply and demand. This is an obvious nod to Russia, the other major global oil production powerhouse aside from the United States.

“The Conference concurs that there is firm and common ground that continuous collaborative efforts among producers, both within and outside OPEC, would help restore the balance and sustainability in the market,” the organization’s representatives said in a release.

Platts RigData analyst Trey Cowan said a successful production curb by OPEC would affect his latest three-year rig forecast, as any self-imposed oil production restrictions by the cartel would serve to lift oil prices, thus encouraging new rig demand. But OPEC would first have to deliver on its promise. In past years, cheating on the established production quota has been the norm for OPEC members, with the exception of Saudi Arabia.

Meanwhile, the rhetoric that came out of Algeria has been enough to boost the oil market.

“This is a teaser right now,” Cowan said.

Cowan is already predicting land rig demand in the United States will expand over the next three years “at a slightly better pace than futures suggest for oil prices.” His forecast has the U.S. rig count expanding by 29 percent year over year in 2017, fueling a projected 25 percent increase in drilling activity.

In an interview, Cowan estimated that current oil futures prices may be around $10 per barrel higher than they are if OPEC had simply frozen its crude output a year ago.

He described himself as “cautiously optimistic” on the chances that the OPEC agreement reached last week would lead to better prices for U.S. drillers. It all hinges on what Saudi Arabia does, Cowan said.

“The big ‘if’ is if they actually do it,” he said. “Let’s just say they actually execute, and everybody doesn’t change and they all follow the rules, and they actually start tapering down their production. That is definitely going to impact where the rig demand would go.”

International Brent crude oil prices were closing in on $50 per barrel before settling lower during late trading Friday. At press time, West Texas Intermediate, the North American oil price benchmark, was close to $48 per barrel. A steady price of around $45 per barrel has encouraged domestic oil companies to add some 70 rigs to the West Texas Permian Basin oil patch since April.

One takeaway from the Algiers agreement is that it is still far too early to write OPEC off, many analysts are arguing.

“OPEC has just demonstrated it is still relevant,” Deloitte Center for Energy Solutions Executive Director Andrew Slaughter wrote in a briefing. “If cuts are even partially implemented this will help move global supply and demand back towards balance, accelerate the decline in global oil stock levels, and confirm that oil prices are on the road to a recovery.”