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Breaking Down The OPEC Deal: Where To Now For Oil?

Saudi Arabia To Shoulder Majority Of Cuts

Wednesday’s OPEC negotiations were mainly centred around Saudi Arabia, Iran and Iraq with input from Russia, the key non-OPEC player. At the end of September in Algiers, Saudi Arabia made its position very clear: whilst Iran, Libya & Nigeria would not be required to cut production, all other members would be required to, including Iraq. Saudi Arabia stated that they were happy to shoulder the burden of the majority of the cuts needed but would not do so alone.
Iraq Agree To Real Cut

Consequently, it was down to Iraq & Iran to adjust their positions, which ultimately they did. Given the previous levels of tension among OPEC member groups, negotiations were always expected to go down to the final minute, which they did. Iran agreed a very small increase, which si being considered close to a freeze, in line with Algiers. Iraq initially agreed to use secondary sources as their baseline though eventually agreed to a real cut. The legacy of Saudi Arabia walking away from the Doha deal in April likely strengthened their bargaining power this time around leading to compliance from Iraq.
Terms of the agreement

The agreement confirmed that OPEC would reduce its total crude output to 32.5mbpd commencing January 1st, 2017. The duration of the agreement is for 6 months after which it can be extended, subject to review, for a further 6 months. The next OPEC meeting is scheduled for May 25th next year.
Outlook For The Cuts

Given OPEC’s troubled history when it comes to compliance, there is an inherent sense of scepticism when assessing the likelihood of the cuts being implemented to the letter. Looking back at dozens of prior cuts suggests that it usually takes at least two to three months to see maximum cuts implemented and that they are unlikely to be achieved within one month. Furthermore, OPEC usually fails in achieving its full production goals as compliance is typically far from perfect. Historically non-compliance has seen the output figure after reductions around 0.5mbpd higher than the stated target level.

OPEC has created a compliance monitoring committee chaired by Kuwait and also comprising Algeria, Venezuela and two non-OPEC countries, however, OPEC’s only means of enforcement is “naming and shaming” by publishing the numbers to exert pressure on any cheaters. However, the real incentive for compliance at this juncture is the price. Low oil prices create a strong motivation for members to support prices with production cuts.

Looking ahead to the assessment date in May, it is likely that the deal will be extended though the production level is likely to be increased and output is likely to be higher into the second half of the year regardless as compliance will likely suffer as Oil prices recover.
What About Non-OPEC?

According to OPEC, non-OPEC producers will add a further 0.6mbpd cuts to OPEC’s own cuts, including 0.3mdbd cuts from Russia who followed OPEC’s agreement yesterday with one of their own. There will be a further meeting of OPEC and Non-OPEC producers on December 9th to finalise and announce these details.

The involvement of two non-OPEC producers on the monitoring committee for the OPEC deal reflects how serious OPEC are about including non-OPEC producers in this deal. The majority of the focus here is on Russia who are clearly the most important Non-OPEC producer. Typically, Russian compliance with OPEC has been poor. Indeed just a few days ago Russian released a statement noting that any cut would be against previous forecasts for higher production.

Put simply, if Russia increases production, but increase it by less than previously forecast, they will count this as a cut. Hence the outlook for Russian compliance is murky. The only positive sign at this stage is that Russian President Putin has been personally involved in higher-level political talks between producers including Iran and Saudi Arabia. His ability to exert pressure on Russian Oil producers could be significant.
Price Forecast Going Forward

Looking at the historical level of non-compliance (around 0.5mbpd) suggests that Oil production should move down to around 33mbpd over h1 2017. As such prices are likely to rise over the year taking Crude out of its current range of $40-$50 this year into the $50-$60 range next year.

The technical picture shows that Crude has now moved back inside the bullish channel which had framed price action this year and is once again challenging pivotal resistance at the 51.60s level. A break here paves the way for a run up to test the 2015 high around the mid 62 level.

Friday, 02 Dec, 2016 / 1:10

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