The Organization of the Petroleum Exporting Countries (OPEC) along with the non-OPEC oil producers have recently reached an agreement, the first such deal since 2001, to a combined oil production cut of around 1.76 million barrels per day (bpd) from January 1, 2017. The proposed output cut amounts to around 1.8% of the global oil output. The countries have agreed to continue with the reduction in the production levels for six months till June 2017, which could further be extended in case the market conditions demand so.
The OPEC countries together have committed to curtail oil production by 1.2 million bpd to bring the production level to 32.5 million bpd. OPEC’s production level stood at 33.9 million bpd in November 2016, which is about 35% of the global oil output of 96.8 million bpd. As compared to the production levels achieved in October 2016, the agreed output cut would translate into a 4.6% reduction in their output levels. [Ref. Tab 1]. Saudi Arabia, the largest OPEC producer has agreed to bear the largest cut in production of about 486 thousand bpd and has even promised to take further cuts should the markets warrant steeper reductions. Libya and Nigeria have been exempted from the deal as their oil output levels have already been hampered by the ongoing domestic conflict while Iran has been permitted to raise output as it recovers from nuclear-related sanctions.
The non-OPEC countries including Azerbaijan, Kingdom of Bahrain, Brunei Darussalam, Equatorial Guinea, Kazakhstan, Malaysia, Mexico, Sultanate of Oman, the Russian Federation, Republic of Sudan, and Republic of South Sudan have also agreed to decrease production by 558 thousand bpd till the market scenario improves. Among these countries, Russia will be reducing production gradually by 300 thousand bpd; by end of March 2017, production will be reduced by 200 thousand bpd as compared to its October 2016 output level which stood at 11.247 million bpd. Mexico has agreed to cut 100 thousand bpd, Azerbaijan by 35 thousand bpd and Oman by 40 thousand bpd.
What prompted the decision of oil production cut?
Over the last two years, the global oil industry has witnessed a glut of oil supply causing prices to crash (hit a low in January 2016), and adversely impacting the crude oil industry and the oil dependent economies. This took the oil producers back to the drawing table to look at output levels and consider possible remedial measures. Higher production by OPEC members and increase in US shale output, have been the major contributing factors for this oversupply scenario.
Unlike the present scenario, during 2011 to middle of 2014, global oil prices hovered within a higher range of around US $ 100 – 110 per barrel. During this period, though there was continuous increase in oil supply resulting from the boom in oil production from US shale and Canadian oil sands, the overall supply of oil remained balanced due to unplanned supply outages from Libya and Iraq, among other places. This supported the oil prices which persistently remained high.
However, the scenario changed in the second half of 2014; unconventional oil production continued to rise significantly, while unplanned outages lessened leading to excess supply of oil, which exerted downward pressure on oil prices. On the other hand, weak demand for oil owing to lower economic activity also resulted in over surplus scenario.
Thus combination of three factors – high shale oil output, lower OPEC supply outages and low demand for oil led to a sharp drop in oil prices. To add to this, OPEC’s decision towards end of 2014 to maintain its output quota which was viewed as a strategy to maintain its market share and squeeze out high cost competitors, exerted further downward pressure on oil prices. As a result, average oil prices crashed from US$ 112 per barrel in June 2014 to US$ 48 per barrel in January 2015, and continued to slide to touch US$ 31 per barrel in January 2016.
The magnitude and the duration of the fall in oil prices gradually started adversely impacting revenues and investments of oil producing companies. Adverse impact on earnings led to decommissioning of oil rigs (in US) and sharp cut in investments in exploration and production. Oil and gas investments dropped by about US$ 340 billion over the last couple of years since 2014 when it had touched a record high of US$ 780 billion. As a whole, the oil industry has been struggling to cover its investment needs and dividend payments for many years. [Ref to Chart 3] It has been reported that even during the period between 2012 and 2014 when the prices were high, the oil companies found it difficult to break even. The situation further worsened after the sharp dip in oil prices, forcing companies to cut down on their investments. The companies either deferred or cancelled new projects.
In September 2016, the oil and gas industry announced a cut of US$ 1 trillion from their planned spending on exploration and development due to the slump in oil prices. This is expected to bring slowdown in oil production, going forward.
OPEC’s final decision
In the wake of the evolving development, OPEC, which refrained from production cut for a long time finally agreed that the current market conditions are counterproductive and damaging to both producers and consumers, as it is neither sustainable nor conducive in the medium to long-term. OPEC in its official statement has acknowledged that ‘the present situation threatens the economies of producing nations, hinders critical industry investments, jeopardizes energy security to meet growing world energy demand, and challenges oil market stability as a whole. Continuous collaborative efforts among producers, both OPEC and non-OPEC could aid in drawdown of the stocks overhang and restoring the global oil demand supply balance’.
In the next two posts in this series on Oil production agreement, we will focus on Impact on oil prices after the OPEC’s production cut announcement and factors influencing the success of the OPEC deal.