Compliance Slippage and All-Out Production Resumption May be Inevitable: IHS Energy

Wednesday February 15, 2017

Victor Shum, VP of IHS Energy Insight, highlighted the inherent self-interest of the Organization of the Petroleum Exporting Countries' (OPEC) output reduction agreement – and the danger it poses to the global market – on Tuesday by noting that if oil prices falter, cartel members who are currently earning vigorous praise for their high compliance will resume pumping, thus causing the opposite of what the agreement was supposed to do: reduce oversupply and bring about market re-balance.

Speaking to CNBC, Shum said it is predictable that OPEC members would flout the agreed-upon cuts as the summer driving season sends prices higher, and he added that as demand grows "output will likely increase; there's going to be a slippage in compliance."

Shum also predicted that OPEC will probably extend the six month deal if prices remain near or above current levels; however, if prices falter, "all bets are off" and exporters will start pumping normally in an attempt to boost government revenues.

Jim Krane, a fellow at Rice University's Baker Institute, suggested that the temptation to boost output may be overwhelming: "It'll be tougher for the Saudis and some of the other Gulf producers to hold production steady during the late spring and through the summer; other producers will be tempted to try and meet surging summer demand rather than hold the line and allow prices to increase."

While faltering prices are something analysts believe could easily happen, especially since the recovering U.S. shale industry has the potential to exacerbate the global glut in the near term, less likely is the chance they will rise much more as OPEC cutback participants are hoping: Tariq Zahir, managing member of Tyche Capital, told CNBC that the market has largely priced in the cuts that the cartel and other producers enacted in January, leaving little room for prices to break out of the current $50-$55 range.

He said, "It would take either a supply outage or serious cuts to move it; the first month, obviously, OPEC is going to do the best it can, but after that, let's see what the second and third month bring."

Although a plethora of uncertainties cloud any outlook regarding where the production cuts and the near-term market are headed, Tamas Varga, analyst for PVM Oil Associates is relying on OPEC itself to suggest a possible course of action.

He told CNBC, "Based on OPEC's own numbers, the message is loud and clear: improve on compliance, cut production further, and extend the deal for the second half of the year if you want to avoid yet another year of global oil inventory builds."

Earlier this week, Essam Al-Marzooq, oil minister for Kuwait, urged non-members such as Russia, Kazakhstan, and Oman to fulfill their cutback commitments; this accompanied findings by Bloomberg that non-OPEC participants have cut 269,000 barrels per day of their pledged reduction of 558,000 barrels - which translates to a mere 48 percent compliance rate.