How much will OPEC’s decision to cut 1.2 million b/d bolster oil price?

LAGOS (Capital Markets in Africa) – In what has been described as a ‘historic decision,’ OPEC member nations have agreed to cut production by 1.2 million barrels per day (b/d) for six months, beginning 1 January 2017. The group has stated that to rebalance the oil market, cuts are necessary not only from OPEC, but also from other key producers. OPEC stated that these non-OPEC producers can achieve at least 600,000 b/d in additional production cuts, with Russia responsible for a proposed 300,000 b/d, though details are set to be finalised in a 10 December meeting with the venue not yet set.

Saudia Arabia’s support for the agreement marks a significant change in its OPEC policy since the November 2014 meeting, when US oil production was rising by more than 1 million b/d year-on-year. However, with the lower oil prices since late 2014, we expect non-OPEC production to decline in 2016 by 0.8 million b/d — a circumstance that enables a prospective OPEC production cut to tighten the market in 2017.

Even if the agreement is only partially adhered to, Wood Mackenzie’s Macro Oils Service expects 2017 to see global stock draws throughout 2017, which would tighten the supply-demand balance.

In the Wood Mackenzie’s most recent Macro Oils report forecasts the oil price strengthening in H2 2017 regardless of an OPEC agreement to reduce its output. Assuming a 1.2 million b/d reduction in OPEC production in H1 2017, Wood Mackenzie forecasts oil price  for Brent in annual average terms to be adjusted upward by $5 per barrel from $53 to $58 for 2017. Given the relative uncertainty about the status of the potential additional cut of 0.6 million b/d of non-OPEC production, which was not taken this into account.

What’s next 
OPEC and several non-OPEC producers including Russia, and possibly Oman, Mexico, Kazakhstan and Azerbaijan and are meeting 10 December to confirm and announce additional supply reductions which OPEC said after the meeting had been agreed. These total 0.6 million b/d and if implemented would tighten the market further although the terms are as yet undefined. OPEC ‘s next ordinary ministerial meeting is set for 25 May 2017, where members will decide whether to roll over the agreement for a further six months.

For US supply, our analysis shows that to drive a step change in US tight oil activity, prices need to stabilise above $55 for several months and continue to increase. This would spread drilling increases across the main US Lower 48 plays, meaning tight oil becomes more than just a Permian story. But over the short term, the scope for substantial increases in production above our base case forecast is likely to be limited.