OPEC Vows To Slash Supply, But Doubts Persist

Among optimists, November’s decision by OPEC to cut crude oil production by 1.2 million barrels per day, the first reduction in output targets since 2008, marked a turning point in the cartel’s credibility. Individual country quotas were allocated and an independent monitoring committee established. Hopes for a normalization of oil inventories were further boosted after 11 non-OPEC countries, including the world’s largest crude oil producer, Russia, signaled they would follow OPEC, committing to cut production by almost 600,000 barrels per day.

The total cuts of 1.8 million barrels per day—around 2% of global production in 2017—were more than the market anticipated, precipitating a spike in prices after the announcement. In addition, Saudi Arabia said it would cut production by more than it pledged at the OPEC meeting. The cuts will last for six months, extendable for a further six months with non-OPEC members expected to mirror the timetable. The apparent unanimity between OPEC and non-OPEC members led analysts to reaffirm their outlook for oil prices.

Bank of America Merrill Lynch expects prices for Brent crude to average $61 per barrel and West Texas Inermediate to average $59 per barrel in 2017. Capital Economics forecasts $60 by the end of the year. But OPEC’s dismal record of adhering to quotas leaves some unconvinced. Previous quotas have functioned more as a floor than a ceiling. Russia reneged on a deal to cut output in 2001, according to Capital Economics.

Alan Gelder, vice president at consultancy Wood Mackenzie, questions the durability of the deal. “We anticipate compliance to be a challenge for these agreements, as history suggests compliance will be poor.” Aside from the systemic risk, laws of supply and demand cast a shadow, as any recovery in prices will spur shale oil producers to ramp up production—the number of rigs drilling for oil rose in December by the most since July 2015.

Still, OPEC’s regrouping has impressed others. “The steep drop in oil prices over the last few years can be partly traced back to the `price war’ inside the OPEC cartel. It looks to us like the war is over,” Francisco Blanch, strategist at Bank of America Merrill Lynch, noted in a December report.