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OPEC’s Production Cuts: Will They Matter?

December 01, 2016

OPEC Office

After weeks of negotiations, OPEC ministers in Vienna on Wednesday agreed to lower their oil supplies to ease a global glut that has halved prices since 2014. The 14 Member Countries worked a deal to cut crude production by 3.6% to 32.5 MMBpd. Even before the news was officially made public, prompt-month Brent crude oil jumped 8% to over $50.00 per barrel. This is OPEC’s first coordinated production cut since 2008 and avoided a credibility crisis for the bloc.

Additionally, Russia, the world's largest crude producer that just reached a post-Soviet production high of 11.2 MMBpd in October, has agreed to contribute half of the 600,000 Bpd of non-OPEC supply that will be curtailed. All told, Wednesday’s agreement means that nearly 2% of the current global oil supply chain could be pulled in hopes of boosting prices to $55.00 in the near term and above $60.00 per barrel next year. In contrast, a no-deal outcome was expected to have sent prices tumbling to $40.00 per barrel or below.

Yet, the lasting price effects for the physical markets must still be defined as unclear. There’s little proof that OPEC will adhere to the targets. Member Countries, for instance, still have great incentive to cheat and extract more oil than their quotas allow. In fact, the 2015 book OPEC in a Shale Oil World: Where to Next?, by Ramady and Mahdi, concluded that OPEC producers have been overproducing to earn extra revenue a staggering 96% of the time.

And there’s growing debate on how much oil OPEC even produces. Iraq, Iran, and Venezuela have all complained that OPEC uses faulty “secondary sources” supply estimates that underestimate their output levels. Naturally, these members want to present as high a number as possible to be allowed to set the highest possible quota.

Further, OPEC has already handed its critical swing producer role to the U.S., where a rebound in oil prices to $60.00 per barrel should ignite production growth that would compensate for OPEC’s reduction. Although production is down 7% this year, the fall in prices has had the surprise benefit of making the U.S. shale industry more efficient and quicker to respond. Since 2014, production costs have been sliced in half, and the U.S. oil rig count has risen four straight weeks in anticipation of an OPEC deal.

The landlocked Bakken producers in distant North Dakota, however, will still need prices to continually climb. The Bakken can have breakeven costs of more than $75 because suppliers pay more to transport crude than other producers, given the pipeline dearth that means more rail and trucking must be used. Once the epicenter of America’s shale oil revolution, the Bakken’s year-over-year production is now down nearly 20% to 920,000 b/d.