Demand could outstrip supply in the back-half of next year, but only if OPEC and non-OPEC producers follow through on cuts

Oil prices leapt over $50 per barrel following OPEC’s agreement to cut production last week, and they could be headed higher next year as the decision leads to a supply deficit in the second-half of 2017. If both OPEC and non-OPEC participants comply with their production cuts, there could be more than a 1.5 MMBOPD deficit in Q3, and a 1.0 MMBOPD deficit in Q4, according to a presentation from Argus Wednesday.

Argus estimates a crude oil supply deficit in 2H'17 if OPEC and non-OPEC producers comply with production agreement.

Actual cuts coming or just empty words?

The question remains though: will producers both inside and out of the cartel actually follow through with production cuts?

Oil prices were down Tuesday as preliminary reports indicated that OPEC continued to increase production up to its meeting last week in Vienna, and non-OPEC members like Russia have a history of non-compliance with OPEC production agreements. A scenario where OPEC and non-OPEC producers actually meet their stated cuts is “very unlikely,” said Sean Cronin of Argus.

Non-OPEC participation, in particular, may prove elusive. Russia has agreed to cut 300 MBOPD over the course of next year, but Russia’s agreement is vaguely worded, and the country has raised production each of the last three times it has agreed to cut production with OPEC.

Russian oil output always rose during the last three production cut agreements with OPEC.

Russia may meet its goals this time around through the use of decline curves, however. The country could shed 200 MBOPD of production just through natural decline, said Cronin. “It looks like Russia will not actively cut production though,” he added.

Politics were the driving factor behind the deal

The driving force behind the deal last week was politics, though. Saudi Arabia and OPEC both needed to show that they still have relevance in world markets.

“This was a very decisive moment for OPEC,” Former Ambassador to Oman Gary Grappo told Oil & Gas 360®. “If they had been unable to reach this agreement, they would have lost all credibility with the international economic community.” “Not only would the lack of a deal reflect poorly on OPEC, but also on Saudi Arabia, which is seen as a major player in the international economic community in part because of its influence in the group.”

This sentiment was echoed by Cronin during the presentation Wednesday. “The political unity around an OPEC/non-OPEC deal was more important than actually getting Russia and other to cut,” he said in response to a question regarding how OPEC might react to non-compliance from producers outside the group.

The real danger to oil prices may come from currency markets, and not concerns over whether or not producers are following their agreements, Wunderlich Director of Equity Research and Chief Market Strategist Art Hogan told Oil & Gas 360®.

“The risk here, in my mind, is not non-compliance, but how strong the dollar gets,” Hogan said. As the dollar increases in value compared to other currencies, it becomes more expensive for buyers to purchase dollar-denominated commodities like crude oil.

“The dollar will probably strengthen in 2017, but not at the same rate that we’ve seen in [November]. The recent strength is a knee-jerk reaction to a Fed that is clearly going to be tightening,” Hogan added, saying that the currency markets usually do a good job of self-correcting.

Next Wednesday’s Federal Open Market Committee meeting is the committee’s final scheduled meeting in 2016 and the year’s final opportunity for a widely expected federal funds rate hike.

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