Has Opec kicked the can down the road again?

The actual decrease in oil market surplus is liable to be muted, as a decline in Opec output might be compensated by increase in output elsewhere


Overnight after the Opec meet, Brent Crude closed at $48.69 a barrel, up 5.92% from the previous close.  Photo: Reuters
Overnight after the Opec meet, Brent Crude closed at $48.69 a barrel, up 5.92% from the previous close. Photo: Reuters

Opec’s (Organization of the Petroleum Exporting Countries) decision to cut oil production, its first since 2008, caught markets by surprise. The Opec conference in Algeria agreed to reduce its output by as much as 740,000 barrels per day. Opec’s August production is estimated at 33.24 million barrels a day (mb/d) and at the upper end, the output cut would amount to around 2% of total production.

Overnight after the Opec meet, Brent Crude closed at $48.69 a barrel, up 5.92% from the previous close.

What will be the impact on India? The country has been a big beneficiary of lower crude prices. For a country that imports most of its oil requirements, higher oil prices are detrimental. They increase inflation and add to the current account deficit. It could also hurt growth. But then, it may be too early to worry.

Dharmakirti Joshi, Crisil Ltd’s chief economist, says the government had increased excise duties on petroleum products and not passed on the full benefits of lower prices to consumers. “That offers enough cushion in the current account deficit till oil prices are in the range of $60-65 a barrel,” he said.

Of course, Indian state run oil producers—Oil and Natural Gas Corp. Ltd and Oil India Ltd will benefit if prices increase.

The big question is: will Opec’s decision move the needle in a big way on oil prices? True, as things stand at the moment, a cut of 0.74 mb/d (at the higher end) has the potential to rebalance oil markets considerably.

In its latest monthly report, before Opec’s latest decision, the US Energy Information Administration (EIA) had predicted a global oil market surplus of around 0.75 mb/d in the December quarter of 2016. Thus, Opec’s move might completely wipe off the global oil market surplus, at least in the short-term.

However, the actual decrease in oil market surplus is liable to be muted, as a decline in Opec output might be compensated by increase in output elsewhere.

Any rise in prices could give further support to the resilient US shale oil producers.

Data from Baker Hughes shows that US oil rig counts have started to inch up in the recent past, suggesting higher production from the US.

Also, Opec’s historical record at sticking to its production target commitments hasn’t been particularly impressive.

Recall that Opec members were locked in a similar tussle over production share for most of 2011, faced with a resurgent Iraq, which was emerging after years of sanctions and war and wanted to increased production rapidly.

Opec reached a compromise at the end of 2011 to collectively limit their output to 30 mb/d.

However, in most of the subsequent months, Opec’s total oil production breached the 30 mb/d target. The adjacent chart shows Opec actual target versus production. Needless to say, oil markets will keenly watch whether Opec matches its words with commensurate actions.

Importantly, the details on the levels of production that each member country will maintain haven’t been decided yet. Opec said it will “study and recommend the implementation of the production level of the member countries.” That will be considered at the November Opec Conference along with consultations between Opec and non-Opec oil-producing countries, to ensure a balanced oil market on a sustainable basis.

Iran, Libya, Nigeria may yet be exempt as statements continue to come out—Iran has said it would like to target 4-mb/d or above, but may be more interested in market share than absolute levels, says Citi Research in a report on 28 September. “In any case, this is still kicking the can down the road to the formal Opec meeting on November 30, where individual country quotas might be decided,” added Citi.

Regardless of any deal, much of this cut would have happened, according to Citi. “Saudi Arabia might be reducing crude output by as much as 0.5-m b/d going into 4Q’16 in any case (from 10.7-m b/d down to 10.2-m b/d), as internal crude oil demand for power generation goes down seasonally after the summer peak.”

In short, while Opec’s move sends a strong signal about its intention to bring stability into oil markets, it is too early to say whether the latest move by Opec will ensure higher oil prices for a sustained period of time. With the can being kicked to November, this is merely a sentiment lifter for the oil markets in the interim.

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