Volatility in oil prices could prompt OPEC to extend supply cut deal

In November 2016, OPEC members pledged to reduce their oil output by about 1.2 million barrels per day (bpd) for six months, starting January 2017. Subsequently, 11 non-OPEC oil producers, including Russia, teamed up with OPEC by agreeing to lower their output by 558,000 bpd.

The deal is in its fifth month, and OPEC members have showed better compliance compared with their efforts during the last such attempt in 2008–09. The latest survey by Reuters shows that OPEC’s oil production declined for a fourth consecutive month in April, as the world’s biggest oil exporter, Saudi Arabia, continued to maintain its oil production below the target level. However, higher-than-expected production by the UAE and Angola weighed on OPEC’s compliance, which slipped to 90% in April from a revised 92% in March.

The supply cut deal is aimed at improving oil prices to US$60 a barrel. However, despite considerable production cuts, oil prices have not recovered as expected and have remained consistently volatile. This can be attributed to unswerving downward pressure on oil due to high global inventory levels, despite the output cut deal. Increasing production from non-OPEC industrialised economies is also adversely affecting oil prices. According to OPEC’s latest monthly oil market report, the group’s oil stock in March stood at 3,013 million barrels, about 276 million barrels above the latest five-year average. US oil and gas companies, in particular, have ramped up production in 2017 as they increase spending amid a recovery in oil prices.

Figure 1: Volatility in oil prices (YTD 2017)

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Source: Bloomberg

Although the deal has failed to revive oil prices, it has supported the oil market. Failure to reach a consensus on a supply cut in November could have pushed oil prices well below USD40 per barrel. Markets participants are now focusing on extending the OPEC deal, as the current deal has failed to lift oil prices higher. Global inventories should be reduced substantially to achieve and sustain higher oil prices. The continuation of OPEC’s output deal could help in curbing oil storage over a period of a year.

OPEC is set to meet again in Vienna on 25 May to decide on extending the cut into the second half of the year. On 15 May 2017, Saudi Energy Minister Khalid al-Falih and his Russian counterpart Alexander Novak signalled that the oil supply cut deal could be extended from the middle of this year until the end of March 2018. If OPEC decides to maintain its supply cut target and extend the deal, it will take at least a year to ease inventory concerns and bolster prices. If otherwise, lower oil prices may persist for a longer period.

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