OPEC's Oil Deal Has a Surprising Downside... for OPEC

On Monday, Saudi Aramco (Saudi Arabia's giant national oil company) confirmed that it would abide by its production cuts under the Vienna Accord, OPEC's deal to cut oil production.

The Saudi commitment is to lower its oil supply by 300,000 barrels a day, and the production action took effect with deliveries this month.

This latest announcement now allows the pact to extend into February.

The Vienna Accord was announced by OPEC on Nov. 30 and marks the first time in years the cartel has taken such an action. Subsequent negotiations with non-OPEC producers, especially Russia, resulted in a breakthrough aimed at improving global crude oil prices by reducing supply.

With the other two leading OPEC producers - the United Arab Emirates and Kuwait - also meeting (or in the case of Kuwait, exceeding) their required production cuts, the accord now has a chance of extending the positive impact of rising prices.

But it does not come without a cost, in one region of the world in particular...

The Accord Will Hold, for Now

Global markets were briefly impacted over the weekend by news that Russia had dramatically increased its production. Some analysts expressed concern that Moscow was scuttling its adherence to the accord.

That would have huge impact, as the agreed-to Russian cut of 300,000 barrels a day matches that of the Saudis.

However, the reaction was overdone.

Moscow calculates its production time frame differently from other countries. As it turns out, the production spike was engineered before the cuts were to take effect. While this may go a bit against the "spirit" of Vienna, it's no worse than what others (including a number of OPEC members) have also done.

The accord provides an aggregate production target of some 27.5 million barrels a day worldwide.

Everybody recognizes that it will take several months for the "new normal" in global oil supply levels to take hold. Remember, as I've noted on several previous occasions in Oil & Energy Investor, it's not how high prices go that will determine the sustainability of a trading range.

It's the floor.

And so long as the Vienna Accord holds, that floor will continue to rise, albeit slowly.

Ultimately, the predictability will come from traders and the way in which they peg contract prices based upon the expected cost of the next available barrel. As the actual pricing floor rises, the contract price will rise in advance, accordingly.

However, the aftermath of the cuts is hardly all good news, especially for OPEC...

Higher Oil Prices Don't Guarantee Higher OPEC Revenue

As the cuts kick in, central budgets already saddled with ballooning deficits from declining crude prices are now facing languished export revenues from reduced sales.

As always, the remedy is a balance between budgets and export proceeds. But this is going to take a while to work itself out.

In the interim, concerns are already surfacing.

The International Monetary Fund (IMF) this week has dramatically reduced its Saudi 2017 growth projection. In the IMF's update of its much-followed World Economic Outlook, that figure has been reduced to 0.4% from the 2% contained in the October WEO projection.

The IMF considered the Vienna Accord the main reason for the reduced estimate.

In a Tuesday piece for OilPrice.com, Damir Keletovic had a good summary of the larger Saudi situation (which I've explained here before):

For 2017, Saudi Arabia expects oil revenue to grow by 46% compared to last year's projections, and non-oil revenue also to increase by some 6.5%. Still, non-oil revenue expected for this year is more than half the amount of the projected oil revenue.

In its budget plan for 2017, Saudi Arabia said that the 2016 deficit was lower than the 2015 shortfall in nominal value. Last week, PricewaterhouseCoopers advised the kingdom on $20 billion worth of projects it could cancel in order to reduce the budget deficit it had amassed with the low oil prices of the past two years. The projects that are under review include housing, health, education, and transport contracts.

Such reforms, however, will move slowly in the kingdom, and the public is sensitive to pay cuts.

It's been decades since Saudi Arabia has had to deal with a budget deficit. While it had a deficit equal to 15% of its GDP in 2015, it managed to decrease that to 12.6% in 2016.

Riyadh is not used to sailing such waters. But it's hardly alone...

All OPEC members are likely to experience similar budgetary pressures as the new reality sets in. As a Persian Gulf contact told me in December, "We have low prices, followed by lower production. Pick your poison."

These constraints will persist whether the IMF chooses to publish a reduction in growth estimate for each country or not.

Meanwhile, the IMF has also cut estimates for non-OPEC oil producers. Both Brazil (0.2% from 0.5%) and Mexico (1.7% from 2.3%) have had reductions in growth forecasts for 2017. The IMF noted that Mexico's larger cut also reflects the "diplomatic tit-for-tat" it has had with U.S. President-elect Donald Trump.

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The post OPEC's Oil Deal has a Surprising Downside... for OPEC appeared first on Oil & Energy Investor.

About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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