OPEC and Friends Are Complying?!?1?

Well folks, less than a month into the OPEC / non-OPEC production cuts and we already have good news: various oil ministers are reporting that 1.5 million barrels per day have been taken out of the market place already of the total 1.8 mpd planned.

Russian oil Minister Alexander Novak stated that he anticipates a total of 1.7 million bpd could leave the supply side by the end of the month.

Venezuela has implemented half of its 95,000 bpd cut, Russia 100,000 bpd (double what they originally planned by this time), and Saudi Arabia is already producing less than 10 million bpd and has informed buyers of substantial cuts scheduled for next month. Even Iraq claims to have already cut 180,000 bpd and plans to reduce output by another 30,000 bpd by the end of this month.

According to Saudi Energy Minister Khalid al-Falih, 100% compliance with the deal will have the effect of taking global oil inventories back close to their five-year average by mid-2017, lowering oil in storage around 300 million barrels.

But despite assertions to the contrary, U.S. shale has to loom large on OPEC’s mind. OPEC has stated that they are not worried about U.S. production because they believe it will be eaten up increased demand. And Saudi Arabia seems to be laboring under the belief that $50.00 a barrel oil is not enough to make a significant amount of U.S. drilling activity profitable. I’m not so sure. Here are the statistics:

1. The oil rig count has risen by 235, or nearly 75%, from its low at the end of May
2. Gas rigs have also rebounded by 61, or 75%, from their own low in late August
3. The new production increase is likely to be even greater because of increased efficiency
4. Big OEMs recently reported a surge in U.S. Drilling (but not a big increase worldwide)
5. Shale producers have all indicated a big increase in their drilling budgets for 2017

In addition, Exxon Mobil has agreed to pay $56.6 billion to double its Shale acreage, and nearly $20 billion in deals were done last year in the Permian alone. Hardly indications of a timid U.S. market, the EIA seems to concur – projecting that 2017 will see 9 million bpd produced in the U.S. – 110,000 bpd more than last year.

And then we have the North Sea. According to recent reports, crude oil from the North Sea is flowing into Asia at record rates filling the void from OPEC . According to current projections, an estimated 12 million barrels will flow from the North Sea to Asia, setting a record.

So, despite the incredibly happy news we are receiving, we must also realize that too much of a good thing can be a bad thing. OPEC has already indicated that they are unlikely to extend production cuts past the initial six months they agreed to according to comments by Al-Falih. Now, of course, this may be OPEC’s way of warning North American producers not to get too comfortable or too greedy.

But it also makes sense. Let’s backtrack the production agreement a little bit from the Saudi perspective. As many of you know from past newsletters, Saudi Arabia generates the vast majority of their electricity through crude. And of course, the time that Saudi Arabia needs electricity the most domestically (and therefore crude) is during the blistering hot summers. Traditionally, Saudi Arabia needs about 900,000 barrels a day of crude just to support its electricity demand during the summer months. However, that changed last year when the kingdom opened a new gas power plant that allowed it to reduce its summer crude demand by about one-third. This meant the Saudis had a bit of a problem: they no longer needed all the crude they thought they did, and if they kept up production, they would be flooding the market in an already flooded market. Viola we have on OPEC deal.

But now, they are wise to the situation and have adjusted production accordingly. It also means that the production deal that got cut made a whole lot of sense from the Saudi’s perspective: they could cut a lot of production from their high point without actually cutting a lot of imports. The next round will not be so easy – particularly during the kingdom’s peak demand season.

Hopefully, world oil demand will continue to rise. That is contingent on a number of factors – particularly continued economic growth in emerging economies. But either way, we still must continue to be incredibly vigilant watching supply and demand, hoping for a resurgence but not getting too greedy.