Two months into their historic experiment, agreements to cut oil production in support of crude prices provide more questions than answers.
A giddy market received a jolt of reality this month, when marker prices slipped below $50/bbl. Stubbornly high inventories in the US reminded buyers and sellers that abundance still dominates.
Yearning for coordination
Clearer now than ever is the market's yearning for supply coordination. Price instability always has bedeviled the oil business. Through most of the industry's history, some mechanism has buffered supply to moderate price: cooperation outside the US by major companies; prorationing by state commissions in the US, production restraint by the Organization of Petroleum Exporting Countries.
Indeed, when OPEC refused in November 2014 to ask members to cut production, the market panicked. And when the group announced at the end of last November that it would reinstate quotas starting in January, Brent crude quickly gained $7/bbl in value, according to the International Energy Agency. Companion promises by a group of non-OPEC producers early in December added $3/bbl more to the Brent price.
Those price hikes materialized before any production cuts occurred and before any assurance was in sight that curtailment would happen. The market's craving of supply management is the clearest message yet from OPEC's project.
On compliance, early signs are encouraging-though maybe wavering. In its Oil Market Report published Mar. 15, the IEA estimates the 11 OPEC members agreeing to cut production met an aggregate average of 98% of their commitments during January and February. IEA "provisionally" estimates the 11 non-OPEC collaborators managed 37% compliance over the period.
But the effort is asymmetric. Saudi Arabia anchors OPEC's performance with a compliance rate of 135%. Angola and Qatar also produced below quotas in February. Kuwait met its quota. And the UAE is approaching its target. Compliance is important. History pointedly suggests Saudi Arabia won't balance the market solo.
Whether Russia will trim output by its promised 300,000 b/d remains a pivotal question. As the most important of the non-OPEC collaborators, it said at the outset cuts would be phased. It's probably paring drilling by state-owned companies, rather than ordering well closures, and letting depletion in old fields do the rest.
To some extent unknowable outside Riyadh, Saudi enthusiasm for supply coordination depends on Russian adherence to the non-OPEC accord. Russia has a less than noble record with promises to trim oil output alongside OPEC. Furthermore, Saudi officials loathe Moscow's siding with Tehran in Iranian interventions in Iraq, Syria, and Yemen. Recent diplomatic gestures-including agreement to let Iran increase production while all but two other OPEC members were cutting-hint at an easing of tensions. Still, reciprocity between Riyadh and Moscow is central to the production accords. Diplomacy notwithstanding, it must be considered fragile.
Beyond questions about cohesion of the supply agreements looms the new unknown: the response to price elevation of prompt production from tight oil plays. The US Energy Information Administration, in its March Short Term Energy Outlook, added 200,000 b/d each to its projections for US crude production this year and next. For the seven shale plays it tracks in its monthly Drilling Productivity Report, EIA recently projected a 109,000-b/d increase in April alone.
With costs and break-even prices falling in some tight-oil plays, with drilling in those plays rising, and with production enhancements occurring steadily, further gains are inevitable. To the extent they're not offset by declines elsewhere outside the production agreements, the increases take market share from parties to the accords. It was that prospect that made OPEC abandon supply management in 2014.
The experiment
The latest version of production restraint thus remains perishable. If it fails, a touchy market will punish oil prices. And surprise supply from tight oil plays seems to be a question of not whether but how much.
A global experiment tests whether production restraint works in an oil market supplied increasingly from unconventional resources. Results so far? Inconclusive.
