Supply disruptions threaten in coming months

After orchestrating the most successful coordinated action by the group in decades, OPEC is now considering whether to phase out its supply cuts.

Since its implementation in January last year, the OPEC cut agreement has seen compliance well above previous attempts at coordinated action by the cartel. The group reconfirmed its commitments to the cuts late last year, agreeing to hold production at current levels through the end of 2018.

While inventories did not deplete as quickly as expected, they have gradually fallen. Current oil storage among OECD nations has reached the five-year average, a milestone that was originally targeted by OPEC when it implemented the cuts. Oil prices are at levels not seen since 2014, with Brent flirting with $80/bbl.

Two OPEC members may see production decrease significantly in the coming months, beyond any commitments related to the cut agreement. The U.S. government has pulled out of the Iranian nuclear deal and threatened to reimpose sanctions, roiling the global oil market. While analyst have predicted a wide range of possible impacts, many believe American sanctions on Iranian oil may keep roughly 500 MBOPD off the market. In addition, Venezuelan production is in free fall, with no signs of recovery on the horizon.

The high oil prices are also pushing OPEC to consider raising production. Countries are naturally eager to take advantage of the revenue available by increasing output. Russian companies are also eager to see production increase, as firms like Lukoil and Rosneft have made large investments in the past few years and are eager to see returns.

While supply disruptions and the opportunity for greater revenue both offer significant immediate incentives to raise production, OPEC is also doubtless considering the effect of high oil prices on their rival, U.S. producers. Investors in E&P companies are currently eschewing growth in favor of cash returns, but many analysts expect sufficiently high prices would herald the return of rapid growth in U.S. shale.

Partial increase in output likely

These considerations have led OPEC to consider its commitment to cuts through the rest of the year. The group is scheduled to meet in June, and may announce a decision at that time. Based on statements from energy minsters, it seems likely that there would be a partial reduction in the output cut, not an outright end. Russian Energy Minister Alexander Novak, for example, stated that cuts could be eased “softly” if OPEC decided to act. Novak commented that the deal will stay in place for now, though Russia and Saudi Arabia have a common position on the future of the deal.

If the group does announce a production increase next month companies will likely move quickly to respond. Rosneft, for example, announced it could bring its production back to pre-cut levels within 60 days, and likely recover most of its output within 30.

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