Agreement by the Organization of Petroleum Exporting Countries to cut production tests several elements of an oil market inclined toward abundance.
OPEC agreements, of course, always test discipline of the participants. It’s the bane of cartels that elevated price breeds overproduction, which undermines the effort. Here, OPEC’s record is varied.
The challenge now is greater than ever. Political tension among important members—Saudi Arabia, Iran, Iraq—is unusually high. For that reason alone, the Nov. 28 agreement to cap group output at 32.5 million b/d is an impressive achievement.
But extramural contingency will test cohesion even more. Atop what OPEC said would be production cuts by members totaling 1.2 million b/d are to be reductions of 600,000 b/d by nonmembers. Of that, 300,000 b/d falls to Russia.
The basic test is whether crude-price elevation is incentive enough to elicit and sustain production restraint by multiple countries with disparate affiliations and interests.
Beyond that, a new complication looms.
In the past, non-OPEC supply took years or decades to develop in response to price elevation. Now, production can start from shale and other tight reservoirs as quickly as producers can drill and complete wells.
What’s unknown is how much incremental supply will emerge when prices rise—now or later.
Within that test lurks another. Producers have lowered costs enough to have revived work in places when crude prices loitered below $45/bbl. Many of them seem confident the new economics will last.
Indeed, some of the savings reflect improved knowledge and skill. But some of them result from painful concessions by providers of services and supplies. If activity strengthens durably, bargains will disappear.
The test is how much improvement in tight-oil economics results from operator cleverness and how much from contractor desperation.
Past recoveries didn’t present this many tests. But past recoveries applied to markets with supply subject to immediate physical and economic constraints—plus the occasional restraint of producers.
This market is different. And the difference means this recovery might be fleeting.
(From the subscription area of www.ogj.com, posted Dec. 2, 2016; author’s e-mail: [email protected])