This FICCI Research team’s Economy Insight series continues from Oil Production Agreement by OPEC and Non-OPEC Countries and Impact on oil prices after OPEC’s production cut announcement
Success of the OPEC deal hinges on compliance
Though the announcement to curtail production of oil has been made public and future price calculations and its likely impact has also been derived, there are still some concerns related to the success of the deal as this would largely depend on the compliance of the OPEC and non-OPEC countries with their agreement. In the past, there have been instances of oil producing nations producing more than their allocated quotas, thereby jeopardizing the results. This time around as well there is skepticism with respect to the extent to which the announced oil output plans would be adhered to by these countries and also how OPEC would enforce the production for a longer period of time.
Russia too in the past has failed to deliver on promises to cut in tandem with OPEC. Additionally, Nigeria and Libya who have been exempted from the deal as their oil industries are in a severely weakened state also could ramp up their production and hence supplies significantly in future, thus neutralizing a portion of the agreed output cut. In earlier instances, some producers even raised output higher than what they were producing before the agreement. However, this time producers may not be able to produce more than their current output, since their run down fields require large amounts of capital investments.
It is worth pointing out that OPEC producers in November 2016 raised output to 33.87 million bpd from 33.72 million bpd in October 2016, which was 1.37 million bpd more than OPEC’s agreed/pledged production target of 32.5 million bpd effective January 2017. Within OPEC, Saudi Arabia and Kuwait both reduced output in November as compared to October, while Angola, Nigeria, Libya and Venezuela were among those who raised their output to a great extent.
Iraq, the second largest producer in OPEC has signed new deals with India, China and US refiners, and it remains to be seen how it would honor the deals and its commitment to cut output by 210,000 barrels per day from January 2017. Analysts have also raised questions on whether some non-OPEC producers are attempting to present a scheduled cut or natural decline in output as their contribution to the deal.
Compliance being a major concern, the deal includes the creation of five-country Ministerial Monitoring Committee to closely monitor the implementation of and compliance with the agreement to curtail production. It would comprise of three OPEC members, Algeria, Kuwait, Venezuela, Russian Federation and another non-OPEC producer which would be chaired by Kuwait with Russian Federation as alternate chair and assisted by the OPEC secretariat.
Another major concern is increase in US shale production as US producers could be one of the biggest beneficiaries of the higher prices, which would provide a boost to US energy companies and give them the impetus to bring back online rigs that had been idled during the downturn. Oil rigs had dropped from around 1600 in October 2014 to 316 as of 27 May 2016. A recovery is already evident with drilling rigs back up at 510 as on 16 December 2016. This could threaten the projected rise in crude oil prices and also raises the chances of US oil producers gaining market share.
Today, there are alternatives to fossil fuel energy and world may intensify its drive to adopt them in the event of oil prices shooting up substantially (over US $ 120-140 per barrel). This could impact demand for crude oil. Energy companies are also considering diversifying into renewables and are ready to up production once crude oil prices rise.
While the above mentioned points would remain critical factors towards the success of the deal, the actual picture would be clear only in the first quarter of 2017.
