Benchmark Brent crude rallied to an eight-month high last week, but the OPEC/non-OPEC producers in a historic deal to curb output cannot afford to be complacent. The risks are not just from the mid-tier and smaller OPEC producers who have been consistently overshooting their quotas -- a recent OPEC report suggests that non-OPEC collaborator Russia may not be keeping its end of the bargain.
The monthly OPEC report, widely read for its data, news and forecasts on global macro-economic oil fundamentals, said in September that the OPEC secretariat data showed Russia pumped an average of 11.26 million barrels per day through the first half of this year, higher than its 2016 average of 11.08 million bpd.
Under its commitment to cut 300,000 bpd from last November's level, Russia should be capping its production around 10.93 million bpd. Going by the OPEC report, the country was 330,000 bpd above that ceiling.
Is the world's largest crude producer, which partnered OPEC's de facto leader Saudi Arabia in crafting a supply restraint policy and shepherded several non-OPEC producers towards last December's agreement, cheating on its own pledge?
The OPEC report noted the contradiction between Russian energy ministry data showing that some oil companies had cut output by around 3% since last October, and an increase in crude and condensate production from several fields over the summer. Nonetheless, the report penciled in 10.98 million bpd for Russian output over the third and fourth quarters of this year, "assuming production of 300,000 bpd below October levels."
The discrepancy between official data from producers and independent estimates is neither new nor unique to Russia. And while it may be hard to nail the truth between divergent data sets, it is easy to see how even reasonable doubt over compliance by the leader of the non-OPEC bloc could jeopardize the entire arrangement.
The 22 OPEC and non-OPEC producers who signed agreements last November and December to collectively remove around 1.72 million bpd, or 1.8% of supply, now stand at a critical juncture -- one that carries marked consequences as they account for around 53% of global oil production.
Stay the course
The world's oil glut of more than three years has proved stubborn, with bloated inventories draining slower than anticipated. Output from the US shale sector has surged since the start of this year on the back of a recovery in crude prices -- not surprisingly, but surely disappointingly for both OPEC and non-OPEC producers, who might have hoped for slower growth. Libya and Nigeria, OPEC members exempt from the output agreement, have both ratcheted up production, adding to the oversupply woes.
The output cuts will have been in effect for nine months at the end of September, and producers are bracing to maintain them for at least another nine months, likely more. Few of these countries would have imagined last year that they would be in for the long haul, or that crude prices may not always be high enough to compensate for the drop in their revenues from lower sales volumes.
And yet, agreeing to roll over the cuts beyond their March 2018 expiration might be one of the easier tasks for OPEC to accomplish. Not because the cuts have provided the producers with a compelling way to shore up oil revenues and get their economies humming again, but rather, the past nine months have proved that removing the current crimp on supply could unleash an unwanted tsunami of oil and send prices plummeting.
With behind-the-scenes negotiations expected to gather steam ahead of OPEC's full ministerial meeting on November 30, some ministers have already begun telegraphing an evolving consensus around extending the cuts. However, the bigger challenges for the OPEC and non-OPEC camps will be finding an antidote to the rise in Libyan and Nigerian production and tightening compliance with quotas.
Saudi energy minister Khalid al-Falih has pointedly raised the issue of some countries not cutting back crude exports in line with their pledged production cuts, suggesting that OPEC monitor exports as a better way of ensuring compliance. This has been discussed at committee-level meetings in recent months, but has not resulted in any new measuring tools or methods.
Meanwhile, non-OPEC producers' compliance with their promised reduction of 558,000 bpd has been weak in contrast to OPEC's discipline.
One of the ways to compensate for the nearly 600,000 bpd of combined production increase from Libya and Nigeria compared with last October -- OPEC's "baseline" for calibrating its reduction -- is for the group and its non-OPEC partners to deepen their cuts instead of simply extending them. Before this, however, OPEC will need to address the problem of six of its 12 members bound by the agreement exceeding their quotas as recently as August.
OPEC has not officially called Russia out on its overproduction. From all accounts, Moscow's compliance has also not been a topic of discussion at the ministry-level OPEC/non-OPEC joint monitoring committee meetings, of which Russia is a member.
However, if Russia did indeed overshoot its target in the first half of this year and possibly beyond, and by too wide a margin, it could provoke resistance to deeper cuts and stricter oversight among the other producers in the coming months, or at the very least, a private resentment and inclination to let their compliance slip, too.
Non-OPEC Kazakhstan, a signatory to last December's production cut agreement, is already under the spotlight. The country is poised to finally begin ratcheting up production from its giant Kashagan oil field, expecting to raise it to 370,000 bpd by the end of this year from 200,000 bpd at present. Kazakhstan wants to renegotiate its production cut agreement.
OPEC member Ecuador, though a relatively small producer, openly broke ranks in July, saying it would be raising production beyond the agreed limit because it needs the money.
Benchmark North Sea light sweet crude Brent vaulted to an eight-month high above $56/barrel in the week of September 18. However, its cross-Atlantic peer WTI lagged, barely managing to clamber over the $50 level. The recovery, coming after weeks of pessimism and bearish market sentiment, is fragile and may prove transitory: Brent received a shot in the arm from a decline in North Sea crude production in recent months as a result of aging fields and seasonal maintenance shutdowns.
The rest of the lift was sentiment-driven, partly in response to the International Energy Agency and OPEC revising up their respective estimates for 2017 global oil demand growth in their September reports, and partly because the market has once again pinned its hopes on OPEC doing the needful to coax the world's supply and demand back into balance.
The producers' group needs to watch the chinks in its armor even more carefully now.
Vandana Hari is founder of Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy commodities sector