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OPEC’s Oil Deal has a Surprising Downside… for OPEC

by | published January 18th, 2017

On Monday, Saudi Aramco (Saudi Arabia’s giant national oil company) confirmed that it would abide by its production cuts under the Vienna Accord, OPEC’s deal to cut oil production.

The Saudi commitment is to lower its oil supply by 300,000 barrels a day, and the production action took effect with deliveries this month.

This latest announcement now allows the pact to extend into February.

The Vienna Accord was announced by OPEC on November 30 and marks the first time in years the cartel has taken such an action. Subsequent negotiations with non-OPEC producers, especially Russia, resulted in a breakthrough aimed at improving global crude oil prices by reducing supply.

With the other two leading OPEC producers – the United Arab Emirates and Kuwait – also meeting (or in the case of Kuwait exceeding) their required production cuts, the Accord now has a chance of extending the positive impact of rising prices.

But it does not come without a cost, in one region of the world in particular…

The Accord Will Hold, for Now

Global markets were briefly impacted over the weekend by news that Russia had dramatically increased its production. Some analysts expressed concern that Moscow was scuttling its adherence to the Accord.

That would have huge impact, as the agreed-to Russian cut of 300,000 barrels a day matches that of the Saudis.

However, the reaction was overdone.

Moscow calculates its production time frame differently from other countries. As it turns out, the production spike was engineered before the cuts were to take effect. While this may go a bit against the “spirit” of Vienna, it’s no worse than what others (including a number of OPEC members) have also done.

The Accord provides an aggregate production target of some 27.5 million barrels a day worldwide.

Everybody recognizes that it will take several months for the “new normal” in global oil supply levels to take hold. Remember, as I’ve noted on several previous occasions here in Oil & Energy Investor, it’s not how high prices go that will determine the sustainability of a trading range.

It’s the floor.

And so long as the Vienna Accord holds, that floor will continue to rise, albeit slowly.

Ultimately, the predictability will come from traders and the way in which they peg contract prices based upon the expected cost of the next available barrel. As the actual pricing floor rises, the contract price will rise in advance, accordingly.

However, the aftermath of the cuts is hardly all good news, especially for OPEC…

Higher Oil Prices Don’t Guarantee Higher OPEC Revenue

As the cuts kick in, central budgets already saddled with ballooning deficits from declining crude prices are now facing languished export revenues from reduced sales.

As always, the remedy is a balance between budgets and export proceeds. But this is going to take a while to work itself out.

In the interim, concerns are already surfacing.

The International Monetary Fund (IMF) this week has dramatically reduced its Saudi 2017 growth projection. In the Fund’s update of its much-followed World Economic Outlook, that figure has been reduced to 0.4% from the 2% contained in the October WEO projection.

The IMF considered the Vienna Accord the main reason for the reduced estimate.

In a Tuesday piece for OilPrice.com, Damir Keletovic had a good summary of the larger Saudi situation (which I’ve explained here before):

For 2017, Saudi Arabia expects oil revenues to grow by 46% compared to last year’s projections, and non-oil revenues also to increase by some 6.5 percent. Still, non-oil revenues expected for this year are more than half the amount of the projected oil revenues.

In its budget plan for 2017, Saudi Arabia said that the 2016 deficit was lower than the 2015 shortfall in nominal value. Last week, PricewaterhouseCoopers advised the Kingdom on US$20 billion worth of projects it could cancel in order to reduce the budget deficit it had amassed with the low oil prices of the past two years. The projects that are under review include housing, health, education and transport contracts.

Such reforms, however, will move slowly in the Kingdom, and the public is sensitive to pay cuts.

It’s been decades since Saudi Arabia has had to deal with a budget deficit. While it had a deficit equal to 15 percent of its GDP in 2015, it managed to decrease that to 12.6 percent in 2016.

Riyadh is not used to sailing such waters. But it’s hardly alone…

All OPEC members are likely to experience similar budgetary pressures as the new reality sets in. As a Persian Gulf contact told me in December, “We have low prices, followed by lower production. Pick your poison.”

These constraints will persist whether the IMF chooses to publish a reduction in growth estimate for each country or not.

Meanwhile, the IMF has also cut estimates for non-OPEC oil producers. Both Brazil (0.2% from 0.5%) and Mexico (1.7% from 2.3%) have had reductions in growth forecasts for 2017. The IMF noted that Mexico’s larger cut also reflects the “diplomatic tit-for-tat” it has had with U.S. President-elect Donald Trump.

PS Here in the U.S., the situation looks quite different. Select, well-positioned shale plays are already profiting from OPEC’s deal. Just this week, my premium members had the opportunity to score a 122.67% win one of them – and that’s just the beginning. Click here to find out more.

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  1. Sgt York
    January 18th, 2017 at 18:54 | #1

    As the Saudies cut production what’s to keep Trump from upping our own Production to offset there desire for more money from us? We can up ours leaving them with a red face marked Stupid.

  2. January 20th, 2017 at 16:33 | #2

    What so many analysts are missing is that the Saudi oil production has peaked or is very close to peaking. Their operational expenses may be the cheapest in the world but they are increasing as their largest fields age and decline. Their largest field, Ghawar, is more than 65 years old. It was discovered in 1948 and started producing in 1951. The oil companies,(private and government owned), over the decades have done a great job in maintaining production from Ghawar. A waterflood (secondary recovery associated with pressure maintenance) was started almost from day one which is a marvelous idea. In 2016, the Saudi’s quietly announced that carbon dioxide gas injection (a tertiary recovery method) was instituted at Ghawar. Similar gas tertiary recover techniques would start in their other old fields as well. This little notice announcement should have sent off alarm bells. The inference that one can draw is that they are having trouble maintaining production at Ghawar. The Saudi’s refuse to release production figures either on a well by well basis or even on a field wide basis. The excuse is that such figures are a “state secret”, but more to the point, as they have admitted, releasing such figures would enable independent analysis of their reserves.

  3. Christopher Greenaway
    January 20th, 2017 at 19:10 | #3

    The cuts of OPEC are larger than what Is shale can produce even at 80% compliance. Let’s see what happens after a few months! Saudis nor iran, Russia.. can survive with oil being below $50

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