– Nick Cunningham: The first month of the six-month OPEC deal is in the books and the early signs suggest that the oil group is thus far coming close to delivering on its promises.
According to S&P Global Platts, the 10 OPEC countries that promised to reduce their production as part of the Nov. 30 deal have achieved a 91 percent compliance rate with the targeted cuts. The combined output from those 10 countries in January was 1.14 million barrels per day (mb/d) lower than October levels. The figures from S&P Global Platts are particularly important to watch because unlike other market watchers, S&P Global Platts is one of the sources used in OPEC’s official “secondary sources” survey in its monthly oil market reports.
For January, OPEC’s total output stood at 32.89 mb/d, while the group has promised to take production down to 32.5 mb/d. The early progress is encouraging because the deal calls for production to average 32.5 mb/d over the six-month period running from January to June. As such, it was an open question about whether or not the data at this stage would be able to demonstrate progress towards the 32.5 mb/d target, or if countries would prefer to wait. Early compliance suggests that OPEC members are serious about reductions and are acting in good faith towards not cheating. At least for now.
Saudi Arabia is going out of its way to keep everyone on board, shouldering a greater volume of cuts than it promised. Although Saudi Arabia was only required to average 10.06 mb/d over the compliance period, it reduced January levels to 9.98 mb/d, according to S&P Global Platts. Saudi energy minister Khalid al-Falih has said several times in recent weeks that his country would stay true to the deal.
Iraq has the most left to do, but it is only producing 130,000 bpd above its target, a level of outstanding reductions that should be manageable to achieve. Overall, OPEC has exceeded expectations thus far. “The smart money is starting to realize that the OPEC production cuts are real,” Phil Flynn, senior market analyst at Price Futures Group in Chicago, told Bloomberg in an interview. “The oil story is beginning to look like the bust-end of the cycle is over.”
But oil bulls should wait to pop the champagne – there are plenty of reasons to worry about the sustainability of the oil price rally. Oil and gas inventories continue to rise in the U.S. as demand has suddenly stalled. Oil production is rising, with gains in recent months coming from offshore projects that have recently come online, a reminder that the shale rebound is just getting underway.
A persistent and growing downside risk to oil is the unusually bullish stockpiling of oil futures by hedge funds and money managers, who have amassed the most bullish trading position on record in oil futures, taking net-long bets to sky-high levels. Bullish bets are a sign of optimism, but everyone running in the same direction is usually a sign that things could swing back in the other direction. As John Kemp of Reuters notes, the ratio of long to short bets has climbed almost to 9 to 1, a lopsided distribution of bets that probably can’t last.
And that is important to keep in mind when watching details from OPEC. Julian Lee of Bloomberg Gadfly warns that OPEC might not be able to keep its coalition together in the coming months. Already, the exempted countries of Nigeria and Libya are adding output back onto the market, offsetting some of the cuts. Saudi Arabia might bring back some production as temperatures – and domestic demand – rise. Iraq’s willingness to lower its output remains uncertain, as it has promised to export a record volume from Basra.
Oil prices enjoyed a huge surge following the successful outcome of the OPEC deal at the end of last year, but have stagnated since. Bloomberg Gadfly argues that the nerves of OPEC members tend to fray as oil prices stop rising, increasing the odds of cheating as 2017 wears on. If OPEC cheats, the non-OPEC countries including Russia that promised cuts will probably abandon their commitments as well.
If OPEC compliance starts to drop, it will probably do so with a backdrop of rising U.S. oil production. The bearish news could spark a reversal in sentiment among hedge funds. Oil traders are “closely monitoring the compliance of the countries involved with the OPEC, non-OPEC production deal,” John Kilduff, a partner at Again Capital LLC, told Bloomberg last week. “Early signs have been somewhat decent, so the market continues to reward their efforts. The positioning is a bit extreme. It could be a cautionary tale that the run may be nearing its end at the same time.”
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