At the 173rd Meeting of the OPEC Conference, OPEC members agreed that the global crude oil market is moving in the right direction. Production adjustments to date are having their desired effect, with inventories falling by half their target amount in 2017.
This reduction in inventories has resulted from a combination of stronger-than-expected demand and high rates of compliance among the OPEC and non-OPEC group with respect to their production quotas.
The pace of inventory reduction is expected to slow (or even reverse course) as we move through a period of seasonally weaker demand, but OPEC anticipates inventories to fall to their 5-year average by the end of 2018 with the extension of supply cuts.
Accordingly, both OPEC and the group of non-OPEC producing countries agreed today to extend the production cuts until the end of 2018. The group intends to assess market conditions next June to consider whether any further adjustments are needed.
Third-party media reports indicate that today’s extension of supply cuts includes Libya and Nigeria for the first time, with an agreed upon collective cap higher than current combined production levels. As such, the inclusion – which will take effect in January – will not have an impact on current production levels.
Prior to today’s meeting, Russia had been intent on discussing the exit strategy in order to gain some clarity on what comes after the market is in a more balanced position. Meanwhile, the Saudi Oil Minister indicated that it is too early for those discussions given that there is still a large amount of inventory that must be eliminated. As of yet, there has been no mention of how these output cuts will be phased out once the market is in balance.
Key Implications
An agreement on extending the production cuts through the end of 2018 was largely priced in. Once the decision had been finalized, market reaction was subdued with prices holding relatively steady.
The WTI benchmark has been sitting in the US$55-59 per barrel range in recent weeks. Given the supply-demand fundamentals, it appears as though oil prices have been bid up too much and are unlikely sustainable in their current range. Now that the extension of production cuts has been confirmed, there is likely to be some profit taking, taking prices back below US$55 per barrel. Barring any significant supply disruptions, prices are likely to sit in the US$50-55 per barrel range until the market moves into a more balanced position.
A key risk for 2018 remains the evolution of U.S. shale production, as it is still a challenge for OPEC. Production there is sitting near record levels and hedging activity has been on the rise. U.S. output could continue to surprise on the upside going forward, acting to delay OPEC’s goal of bringing inventories down to the 5-year average by the end of next year.
