Oil Jumps as Saudis And Russians Agree to Extend OPEC Deal Into 2018

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What Saudi Arabia’s Oil Minister said in March will not happen, has happened: in a joint statement, Khalid al-Falih and his Russian counterpart Alexander Novak said that OPEC and Russia have agreed to extend the oil production cut deal struck at the end of last year until March 2018.

The news immediately sent prices higher, although the rise was capped by yet another weekly build in the number of active drilling rigs in the US, bringing the total up to 885—an increase by 479 rigs over the past 12 months, along with production increases in Libya.

At around US$49 a barrel for WTI and US$52 for Brent, the benchmarks are basically where they were at the time the initial OPEC deal was announced. In the first few weeks after the announcement, prices spiked to US$55-56 for Brent and US$54 for WTI, but that didn’t last long: there was too much doubt among investors and traders that the deal would succeed.

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In the beginning of the production cuts, the initial cause for worry was that some OPEC members would cheat as they have a history of doing so. As compliance continued growing at a steady, commendable rate, another problem came to the fore: US shale producers were expanding production in a no-nonsense manner. Crude oil inventories in the world’s top consumer were rising by millions of barrels every week and global stockpiles remained stubbornly above the five-year average.

The general conclusion at the end of the first quarter was that OPEC and its partners in the cut had quite simply failed to accomplish their stated goal. The conclusion forced itself despite overcompliance on the part of Saudi Arabia, Angola, and Qatar.

OPEC’s largest producer surrendered the number-one spot in global production to Russia by cutting its output to below 10 million bpd, while Russia, compliant with the deal, still pumped over 11 million bpd in March. Of course, Moscow had agreed to a much smaller cut than Riyadh, at 300,000 bpd versus 486,000 bpd.

Meanwhile, US production jumped to 9.3 million bpd as of end-April, with the EIA forecasting it to hit 10 million bpd in 2018. Now, there is a dispute regarding US shale production with some observers claiming the production growth is unsustainable, and most producers are simply going deeper into debt while trying to prove a point.

This camp notes that while some parts of the shale patch, notably the Permian Basin, offer low production costs, this is certainly not the case across the entire patch.

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The industry itself is vocal about its efficiency improvements that have helped to bring down production costs consistently, and argues that this trend will continue despite already rising costs as oilfield service providers increase their prices with demand for their services outstripping supply after two years of layoffs and cost cuts.

Yet, the numbers speak for themselves: the US is pumping more oil by the week, and is offsetting the cuts made by OPEC and Russia (most of the other non-OPEC producers that agreed to contribute to the cut are either too small to make a big enough difference or non-compliant, like Kazakhstan and Malaysia.).

Now that prices have started going up again, chances are that the growth in US production will continue and even intensify. A new Rystad Energy report said that even if prices fall to US$40, shale producers will continue growing production.

That was the reason Khalid al-Falih said in March that Saudi Arabia will not agree to an extension, as it would only help shale producers. Now there doesn’t seem to be a choice. It’s either extend or suffer oil back to the US$30s, which most OPEC members—and Russia—cannot afford.

What’s worse is that as shale boomers ramp up output further, prices will inevitably start sliding back down, however strictly the cutters stick to their quotas. It is becoming increasingly obvious what some analysts and industry insiders have been saying for a while: US$50 per barrel is the new normal. Live with it or go under.

By Irina Slav for Oilprice.com

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