OPEC Appears To Actually Be Doing What They Said They'd Do

Nobody gave OPEC much credit when it started making moves to get oil-producing countries to agree to a deal to cut or freeze their production. Crude oil has been on a downward spiral for much of the last five years—though the decline became more pronounced in mid-2014. 

The main reason for the weakness in oil prices is the dynamics of supply and demand. There's a supply glut in oil caused by U.S shale oil and the return of some producers such as Iran and Libya to the oil market. Conversely, the demand for oil is being reduced by decreasing reliance on fossil fuel for energy. 

On November 30, OPEC got its member nations to agree to cutting production by 1.2 million barrels per day. Other non-OPEC producers such as Russia also committed to cut their production by about 600, 000 barrels per day. The last time OPEC succeeded in getting producers to agree to a production cut in 2008, the Brent crude rose from slightly above $30 per barrel to $50 per barrel. This piece seeks to explore the effects of the current production cut on oil prices.

Here's What We Know About How The Output Cut Is Holding So Far

On February 10, the International Energy Agency (IEA) reported that OPEC is seeing record compliance on the agreement to reduce oil output among member nations. The IEA observed that OPEC's production in January dropped to 32.06 million barrels per day in January, a decline of about 1 million barrels per day from the cartel's October baseline. The IEA notes that the output cut “is certainly one of the deepest in the history of OPEC.”

On February 13, OPEC released a report that agreed with the earlier report from the IEA. OPEC revealed that its January oil production output was down about 890,000 barrels per day in relation to its December production volumes. OPEC member nations produced 32.139 million barrels per day in January 2017 compared to their output of 33.029 million barrels per day in December 2016.

OPEC has so far recorded about 90 percent compliance with among member nations on its plan to reduce output. Saudi Arabia is leading the cuts with a massive 496,200 bpd shaved off its production in January. Iraq reduced its production by 165,700 bpd, UAE reduced its production by 159,00, and Kuwait is also holding its ends of the bargain with production cuts of 141,200 bpd.

Interestingly, oil prices have been booking decent gains since OPEC agreed to the production cuts, as shown in the chart above. Since OPEC announced the production cut last year, the Brent Crude has climbed 14.74 percent and the West Texas Intermediate is up a decent 7.29 percent. Brent crude currently trades around $55 per barrel and the West Texas Intermediate trades around $53 per barrel.

The Coast Is Not Yet Clear For Oil

Oil prices ought to have recorded bigger gains in the wake of OPEC surprising success in following through on the production cut deal. However, gains in oil prices have not been impressive mostly because the effects of the production cut have already been baked into oil prices.

Crude oil started booking gains when the chatter about a potential output began. And after the output cuts were announced, prices soard nearly 20 percent. Robert Taylor, an analyst at Saxon Trade observes that "the market can't seem to build up enough momentum for a rally, investors are mostly bidding their time as they watch for convincing signs that oil deserves to climb higher."

The bigger reason oil price are not yet in the clear is that investors are worried that the production cut might not be effective in restoring a balance in the demand and supply dynamics. To start with, OPEC excluded two of its biggest producers, Nigeria and Libya from the production cuts and it allowed Iran to raise its output slightly.

The problem however is that continued production from those producers can actually offset the production cuts from other member nations. The fact that some producers are reducing their output doesn’t necessarily mean that the supply of oil will fall.

Keep in mind, the compliance level from non-OPEC oil producers is still low, and there are fears that they may not follow through. For instance, Russia reduced its January output by a commendable 100,000 bpd, but its production cut is massively below the 300,000 bpd that it agreed to cut.

In addition, OPEC's production cut could provide a window for non-OPEC producers, especially U.S. shale oil producers, to get a stronger foothold in the global energy market. The IEA admits that U.S., Canada, and Brazil (none of which has agreed to cuts) could increase their output by 750,000 bpd in 2017.