Now the hard work starts for OPEC’s planned oil output cut

Under-promise and then over-deliver is a well-worn tactic to boost one’s fortunes, with OPEC’s somewhat woolly promise to cut crude oil output the latest example of this strategy.
Virtually nobody thought the oil producer group had even the remotest chance of reaching an agreement on production at its informal meeting this week in Algeria, a view that was constantly reinforced by OPEC’s energy ministers in comments and interviews.
Yet the meeting ended with the group committing to reduce output by as much as 740,000 barrels per day (bpd) from the end of the year, the first agreement on cutting production the group has managed in eight years.
This tentative deal sent the price of Brent crude soaring as much as 6.5 percent to a high of $48.96 a barrel on Wednesday, showing the value of surprising the market.
But the real question is whether this is the start of sustainable gains for the oil price, and much will depend on what OPEC actually does, and how the rest of the producers respond.
Firstly, apart from the shock value of delivering an agreement, all OPEC actually did was kick the can down the road to their November meeting.
However, let’s not underestimate the significance of even a tentative agreement without flesh on its bones.
OPEC is an organization that has been riven by regional rivalries in its recent past, which has undermined its effectiveness and credibility.
The obvious tension between top producer Saudi Arabia and would-be No.2 Iran has been palpable, so the mere fact that they can reach even what appears to be an in-principle agreement is quite an achievement.
The real work now has to be done by November, as each OPEC member figures out what it is prepared to do in order to reduce the group’s output from around 33.24 million bpd currently to the newly-agreed 32.5-33 million bpd.
It would seem that the bulk of this burden will have to fall on Saudi Arabia, not only because it is the biggest producer, but also because the others such as Iran and Iraq are still trying to boost their output.
Other OPEC members such as Libya and Nigeria are currently producing well below historic levels because of internal conflicts, while others such as Venezuela and Angola are in such dire fiscal positions that they simply cannot countenance pumping any less oil.
Saudi Energy Minister Khalid Al-Falih already hinted at this on Tuesday, in saying that Iran, Nigeria and Libya would be allowed to produce “at maximum levels that make sense” as part of any output limits.
Given that it’s known that Iran wants to up its output from the current 3.6 million bpd to around 4 million bpd, this means to effect an overall OPEC reduction of about 740,000 bpd, more than 1.1 million bpd would have to be cut elsewhere.

SAUDIS, NON-OPEC THE KEY
Finding OPEC members willing to reduce output at all may be tricky, other than some token amounts from the more minor members.
Basically it comes down to whether Saudi Arabia is prepared to pull back their production by perhaps as much as 1 million bpd, or roughly 10 percent of their current output.
Simple maths suggests that if you forego 10 percent of your output you need at least an 11-percent increase in prices to compensate for the lost revenue, meaning Brent would have to rise about $60 a barrel and stay there for it to make financial sense for the Saudis to carry the bulk of the burden of lowering OPEC’s output.
This likely means that the Saudi Arabia will be pushing for Iran to limit its production, and will also be putting pressure on Iraq as well, arguing that it’s not feasible for the kingdom to take all the pain alone.
The other wild card is how other producers around the world react.
Russia, the largest exporter outside of OPEC, may be prepared to join output curbs if it believed it would result in a sustainable price rise.
But oil output in the US may well reverse its recent declines and start rising again as producers there aren’t beholden to anything other than the profit motive.
US shale oil output is expected to drop for an 11th straight month in October, according to the Energy Information Administration.
But higher crude prices may lead to a rapid reversal in US crude output as shale producers have shown they can boost pumping fairly rapidly.
It’s also likely that any sustained price rise will lift output in other non-OPEC producers such as Canada and Brazil.
Overall, there are good reasons to be skeptical as to whether OPEC’s first agreement since 2008 will actually be implemented, or even work if its does. 
But it does show that those writing the group’s obituary will have to wait a while yet.

Source: Arab News