Commodities

OPEC not yet at the finishing line

In early December, 10 OPEC and 11 non-OPEC countries agreed to joint production cuts totalling just shy of 1.8 million barrels per day for the first six months of 2017. This step was aimed primarily at restoring balance on the oil market and at stabilising the oil price. The production cuts got off to a promising start: the Joint OPEC/Non-OPEC Ministerial Monitoring Committee (JMMC) confirmed 94% compliance for February including the part of the non-OPEC countries that had signed up to the agreement, which was an eight percentage point improvement on January. However, a closer look at the figures reveals that the high compliance achieved in the first two months was thanks in the main to Saudi Arabia. In February, up to two thirds of all the OPEC cuts were attributable to Saudi Arabia. If we leave Saudi Arabia out of the equation, the other countries combined only fulfilled their part of the deal by approximately half – on the basis of the Reuters survey. The most recent OPEC report not only confirmed continued high compliance in March with the production cuts – at 104% – but also shows a more balanced burden sharing between the participating OPEC countries (Chart 1). As such the production cuts are more broad-based, which makes continued high compliance in the second quarter more probable and increases the chances of the cuts being extended until the end of the year.

Chart 1: Saudi Arabia no longer bears brunt of production cuts almost on its own

OPEC compliance per country in March

Chart 1: Saudi Arabia no longer bears brunt of production cuts almost on its own
Source: OPEC, Commerzbank Research, as of 12 April 2017

Compliance with the production cuts among non-OPEC countries has proved somewhat sluggish at the beginning. OPEC estimated that the non-OPEC countries that had signed up to the agreement implemented only roughly half of the promised cuts in February. This was particularly true of Russia, which up to and including February had only reduced its oil production by 100,000 barrels per day as compared with the reference level from last October. A noticeable improvement was also seen here in March, however. According to the Russian Ministry of Energy, the production level in March was 200,000 barrels per day below the October level, which would mean that Russia had fulfilled its promise for the first quarter. According to Energy Minister Novak, oil production until the end of April was set to be 300,000 barrels per day below the benchmark level, meaning that Russia would even achieve the level promised for the end of the second quarter prematurely. It is impossible to say for certain how reliable these figures are. As at mid-April, Russian oil companies have not released any production figures that would confirm the data from the Ministry of Energy.

At first glance, the situation after three months of production cuts looks reasonably positive. All the same, the cuts are unlikely to achieve their real objective, which is to reduce the record-high inventory levels. According to the International Energy Agency’s (IEA) monthly report, commercial oil stocks in the OECD countries actually climbed again in the first quarter by 38.5 million barrels or 425,000 million barrels per day. In the first three months of the year, US crude oil stocks seen in February and March points to a continued inventory build. Since the beginning of the year, US crude oil stocks have risen continuously every week but one. By the end of March, the inventory build had totalled 56.5 million barrels. This is due not only to seasonally lower crude oil processing by refineries in the first quarter and increased oil production. Crude oil imports also made strong gains, which contradicts the theory of tighter supply on the world market, as does the fact that OPEC shipments in oil tankers on the world’s seas have of late remained just as high as ever. The fact that China’s oil imports climbed to a record level again in March also raises doubts about any tighter availability of crude oil.

An extension of the output cuts is likely in our view. After all, OPEC will not achieve its goal of reducing OECD oil stocks to their five-year average level by the middle of the year. In the first quarter, there was still an inventory overhang of just shy of 330 million barrels (Chart 2). Judging by the IEA’s recent supply and demand estimates, a noticeable inventory reduction will only be seen in the second quarter. A further significant inventory reduction is only on the cards in the second half of the year if OPEC keeps its production curtailed. Then the production cuts would begin to have their desired effect as demand picks up noticeably and push the oil market into deficit. This is a clear argument in favour of extending the agreed cuts. If OPEC production were maintained at its current level, OECD stocks would fall back to their five-year average level by year-end on the back of the then likely substantial supply deficits of 1.0 million barrels per day in the third quarter and roughly 1.5 million barrels per day in the fourth quarter (Chart 3). If OPEC production returned to the level at which it found itself in the fourth quarter of 2016, the oil market would be balanced in the third quarter thanks to growing demand, and would actually be undersupplied to the tune of 1 million barrels per day in the fourth quarter. In this case, only approximately a half of the targeted inventory reduction would be achieved by year’s end. If OPEC oil production were to be increased more sharply, the rise in demand in the second half of the year would be more than offset, and inventories would even start to rise again (Chart 4).

Chart 2: Commerical stocks in the OECD countries still hover far above the five-year-average

Deviation

Chart 2: Commerical stocks in the OECD countries still hover far above the five-year-average
Source: IEA, Commerzbank Research, as of 13 April 2017
Chart 3: If the production cuts were extended a significant supply deficit would loom in H2
Chart 3: If the production cuts were extended a significant supply deficit would loom in H2
Source: IEA, Commerzbank Research, as of 13 April 2017
Chart 4: If OPEC production were expanded considerably in H2, though, no inventory reduction could be expected
Chart 4: If OPEC production were expanded considerably in H2, though, no inventory reduction could be expected
Source: IEA, Commerzbank Research, as of 13 April 2017

OPEC would lose market share to non-OPEC countries in the case of output cuts being extended until the end of 2017. In our opinion it is unlikely that Russia will sign up to any such extension, as Russian oil companies have made it abundantly clear recently that they plan to scale up their oil production during the course of the year. In the US in particular, all the signs point to oil production being expanded considerably. According to Baker Hughes, drilling activity in the first quarter of 2017 rose more sharply than at any time in nearly six years. The U.S. Energy Information Administration (EIA) reports that capital expenditure by 44 US onshore-focused oil production companies soared by 72% year-on-year in the fourth quarter. This is the steepest increase in nearly five years, even though a slump in 2015 means that the basis for the year-on-year comparison was low. According to a survey conducted by the Dallas Federal Reserve (Fed), sentiment among oil companies in the US improved further in the first quarter, the improvement encompassing all areas covered by the survey. Oilfield services firms in particular reported that business was enjoying a robust revival. They can be regarded as a leading indicator of oil production. According to the Dallas Fed, the further increased production index in the survey points to an accelerated rise in oil production. It is therefore perfectly possible that the IEA is underestimating the growth in US oil production this year. This is all the more true of the EIA, which only forecasts a noticeable production rise in the fourth quarter of 2017 and in 2018 (Chart 5).

Chart 5: US oil production likely to pick up noticeably

Oil rig count, production in million barrels per day, from March 2017 EIA production forecast

Chart 5: US oil production likely to pick up noticeably
Source: Baker Hughes, EIA; Bloomberg, Commerzbank Research, as of 11 April 2017

The debate over whether to extend the production cuts is likely to lend support to oil prices until the OPEC meeting at the end of May. We therefore expect the Brent oil price to remain above USD 50 per barrel in the second quarter. Because Russia and most other non-OPEC countries are no longer likely to sign up to any extension, the cuts will find themselves on a narrower footing. By extending its production cuts until the end of the year, OPEC will lose market shares to non-OPEC countries. This also applies against the backdrop of rising oil production in the US. This would be tantamount to admitting defeat – after all, it was precisely this situation that had prompted OPEC at the end of 2014 not to curtail its oil production as it had previously been accustomed to doing. Compliance with the production cuts by individual OPEC countries is therefore likely to crumble quickly because they will be scared of losing their market share. Admittedly, Saudi Arabia will probably attempt to maintain the agreed cuts for as long as possible, because it is interested in seeing a stable oil market ahead of the planned IPO of its Saudi Aramco oil corporation next year. In the long run, however, Saudi Arabia will not be willing to keep the cuts going all on its own. We are therefore sticking with our forecast that the Brent price will come under further pressure during the course of the year – despite the anticipated extension of the OPEC production cuts – and will fall to below USD 50 per barrel by the end of 2017.