The oil market received a fairly significant bump this week when Saudi Arabia and Russia announced that they both support extending the current OPEC and non-OPEC production cuts for an additional nine months – until the end of March 2018. Russian oil minister Alexander Novak had said Russia was undecided about whether the oil cuts needed to be extended beyond June 2017, so this reflects significant movement from Russia’s position as recently as April 2017.
Now the two most significant oil producers in the production cut deal appear to be in agreement, ten days before OPEC’s regular meeting in Vienna. It seems that an extension of the production cut agreement is practically assured.
The significant remaining questions are:
1. Can Saudi Arabia and Russia convince key OPEC and non-OPEC members to agree to extend the cuts for nine months as opposed to just six months?
Most OPEC countries will be on board with extending the production cuts into the first quarter of 2018. Iraq, which has made no secret of its desire for an exemption from the production cuts, finally announced, on May 11, that it would support extending the cuts for an additional six months. Iraq might be tough to sell on the additional three months, but will likely acquiesce.
Iran, which opposed last November’s OPEC production cut deal until it received a special exemption, is expected to support the OPEC consensus. Iran’s crude oil exports decreased in April and are expected to fall even more in May.
Surprisingly, the non-OPEC country of Kazakhstan has emerged as the only significant opposition to the nine-month production cut extension, saying that it supports extending the cuts in principle but “will not be able to join this (extended cut) agreement automatically on the same terms.” This is due to expansions in the Kashagan oilfield. In any event, Kazakhstan is not an influential enough oil producer to derail this deal.
2. Will OPEC and non-OPEC countries make additional cuts?
There has been some talk of deal participants deciding to make even deeper production cuts when they meet on May 25 in Vienna. It is unlikely that OPEC will want to jeopardize the current consensus that has helped raise prices over the last week. Russia recently mentioned that between three and five additional oil producing countries might join the current production cut deal. So far, only Turkmenistan has indicated an interest in joining the cuts. More participating countries will help the group.
3. How will this affect the shale oil industry in the U.S.?
Further production cuts by OPEC and other oil producers will continue to encourage U.S. shale producers and, more importantly, those who continue to loan them capital. Higher U.S. production will exert downward pressure on oil prices. The most recent EIA shale oil productivity report shows that shale oil production will continue to grow in June. However, there are signs that shale oil growth will not continue at quite the same rate. Rising service costs are expected to eat into shale profits. Profitability points vary greatly for shale, even within the same field, and there are reasons to suspect that claims of profitability from some fracking operations are unreasonably low. Shale oil will continue to expand but perhaps not at the same rate as it has over the past few months.
4. How does political unrest and economic turmoil in Venezuela play into the production cut deal?
As recently as a few months ago, Venezuelan oil production was at 1.9 million bpd. With continued national trouble, Venezuela is finding it difficult to maintain production. If Venezuela’s production problems are exacerbated or production ceases altogether, this could decrease the incentives for deal participants to continue their own cuts. On the other hand, if deal participants continue to abide by the agreed upon cuts and Venezuela’s production drops due to instability, then the impact on global oversupply would be significant and prices would rise accordingly.
Despite the events in Venezuela, it does not appear that that country’s instability has been priced into the oil market. If unrest continues the market will have to take note and price will rise.