OPEC member states, with support from Russia and other non-member allies, agreed this week in Vienna on a deal to maintain production cuts for another nine months. The production ceiling extension, originally envisaged as a short-term prop to bring oil inventories back to historically levels, could expire in March.
The extension effectively establishes a new floor for prices that’s well above the lows seen last year. The extension also benefits OPEC members Nigeria and Libya who remain excluded from cuts due to outputs curbed by unrest.
However the markets did not quite clap back as it reacted to fears of a lack of an exit strategy along with fears of the long term effect of surging U.S. shale output. Brent crude and Futures in London fell on the decision, wiping out most of the gains since Russia and Saudi Arabia publicly endorsed and pledged their commitment to the extension.
Russia’s energy minister, Alexander Novak, moved to reassure the markets of Russia’s and other non OPEC member’s commitment to the deal describing the collaboration with OPEC as pivotal. He also said Russia and OPEC have the means and the will to further support crude prices if needed.
He sought to assuage fears of analysts and the markets in the aftermath of the market gyrations after the meeting. He said:
“It happens all the time, these fluctuations. Extending the agreement was a very important long-term fundamental decision which will help in rebalancing the market and bringing back investment. We could have seen a much worse market reaction if no decision to extend the declaration of cooperation was taken.”
Saudi Energy Minister Khalid Al-Falih also said after the meeting:
“We’ve said we’ll do whatever is necessary.”
Inspite of the assurances from Russia and Saudi Arabia, US production is at a record high.
Rising U.S. production has meant oil inventories remain well above the level targeted by OPEC ministers. The price impact of production cuts made by OPEC and its allies continues to be diluted by rising U.S. shale oil production.
The extension is expected to accelerate U.S. shale oil output even further. In 2018, global oil inventories could increase by about 600,000 bpd in the first quarter, followed by about 500,000 each quarter for the rest of the year.
This would benefit U.S. shale drillers, who could benefit from this week’s deal, a double edged sword raising concerns of oversupply long term.
OPEC and allies may then be forced back to the drawing board to find a way to pull the rabbit out of the hat for a longer term and sustainable structural intervention.