Oil Producers Comply With OPEC Deal to Cut Output, but for How Long?

Source: By STANLEY REED, New York Times • Posted: Tuesday, February 14, 2017

OPEC ministers at the cartel’s meeting in Vienna in November. Ronald Zak/Associated Press 

When OPEC and other major oil exporters agreed late last year to limit production as a way to bolster teetering prices, many saw it as a shaky deal by a spent force.

That perception, though, has changed. And oil prices are up 20 percent since the agreement was reached.

New data published on Monday by the Organization of the Petroleum Exporting Countries shows that the cartel’s 13 members have largely complied with the production cut.

“So far this is holding up way better than any previous agreement had,” said Bhushan Bahree, an OPEC analyst at the research firm IHS Markit.

Still, questions remain about how such a disparate group of countries will be able to hold together, and how much clout OPEC has in a market that has changed radically in recent years.

Here is a quick rundown of the deal, its implementation, and its implications:

What made it possible?

In short: financial pain.

Oil prices began falling in late 2014, when OPEC decided not to cut production as a way to stabilize prices. From a high above $100 a barrel earlier that year, prices fell below $30 a barrel in early 2016 before recovering modestly.

That played havoc with the government budgets of major oil producers, pushing even Saudi Arabia — OPEC’s biggest member by oil output — to borrow large sums in financial markets and to risk antagonizing its citizens by raising energy prices and cutting government salaries.

What followed was a year of sometimes cliff-edge negotiations to reach the deal that was eventually announced in Vienna on Nov. 30.

Had the producers not agreed, prices could have fallen further. “People got pretty close to the abyss and looked down, and it was pretty deep,” Daniel Yergin, an oil historian, said in an interview. “As a consequence they stepped back and did something.”

Russia’s shift to looking for production curbs was crucial, OPEC officials say. It gave the Saudis, who had insisted they would not cut output on their own, the comfort to agree to limits.

Are producers complying?

The early results indicate, for the most part, yes.

The estimates released by OPEC on Monday showed that its members made more than 90 percent of the agreed cuts in January, the first month that the deal was in force. OPEC says the figures are based on secondary sources, rather than on data from the members themselves, and that the figures largely confirm data published on Friday by the International Energy Agency in Paris. That monitoring group said OPEC had reduced its production 3 percent, equivalent to 90 percent compliance.

“We are pretty confident that the picture we have come up with in January is not going to change very much,” said Neil Atkinson, head of oil markets at the agency.

Big countries appear to be holding to the deal. Saudi Arabia cut its output by more than it had initially promised, to less than 10 million barrels per day. Kuwait, Iraq and the United Arab Emirates also made large reductions, although Iraq and the U.A.E. both fell short of their pledges.

Russia, which is not a member of OPEC but which did sign the deal to cut production, also lowered its output in line with promises, according to the International Energy Agency. How much was cut by other producers outside the cartel is not yet clear.

Is it working?

In a narrow sense, it is. Prices rose after the deal was announced, and they have largely held steady, around $55 a barrel.

But oil producers also had another goal: to drain the huge stocks of crude oil and refined products, like gasoline, that have built up in recent years and are blamed for keeping prices low.

It is unclear, however, if that strategy will work.

The I.E.A. estimates that if OPEC maintains its current level of compliance with the Vienna deal, demand would outpace supply, helping to reduce those stocks. But, the agency says, it could take more than a year to bring inventories down to longer-term averages.

And while OPEC and Russia are cutting back, other producers are trying to take advantage of the higher prices.

The United States, where production fell by 1 million barrels per day between April 2015 and September 2016, is now raising output again. Increases in North America, Brazil and elsewhere may at least partly offset the impact of the cuts by OPEC and Russia.

Will they stick together?

That depends. Most analysts think they will stay relatively close to the agreed targets for the next few months. And there is also a good chance that the agreement will be renewed when it expires at the end of June, especially if it is seen as working but in need of more time.

“Saudi Arabia and other producer countries are feeling the pain of low oil prices and thus will likely stay the course if cuts prop up prices,” said Jason Bordoff, director of the Center on Global Energy Policy at Columbia University. “But the deal may unravel if those cuts are just offset by strong non-OPEC production growth in places like the U.S., Canada and Brazil that keeps prices low.”

In the longer term, keeping output low may not be in the interests of major producers like Saudi Arabia and Russia. Those countries have large reserves and can extract oil at low costs.

In the past, they have calculated that oil in the ground would be worth at least as much in the future. But that trade-off has shifted as new technology has made more oil available and as renewable energy and electric cars have appeared to reduce long-term demand.

It may make more sense for the major producers to pump as fast as they can, to try to gain market share rather than risk leaving oil in the ground.

What does it mean for consumers?

A lot.

Gasoline prices in the United States have risen about 7 percent since the deal was made, to an average of $2.29 per gallon for regular gasoline, according to the United States Energy Information Administration.

Crude oil accounts for a little over half the price of gasoline, with the rest coming from costs like refining, distributing and marketing the product, as well as taxes.

Therefore, gasoline prices are likely to follow those of crude. And oil prices also influence the costs of other energy sources like natural gas.