Reliable estimates put OPEC compliance at a jaw-dropping 98.5 percent for February. According to Platts, the ten OPEC members bound by the November 30 supply pact produced 1.24 million barrels a day (b/d) less in February than they did in October 2016—the benchmark adopted in Vienna. That was even better than January, when OPEC surprised the market by achieving 91 percent compliance right out of the gate. Under different circumstances, surely, rates this high would be celebrated.
But OPEC kingpin Saudi Arabia is stoic as ever. Even if compliance surpasses 100 percent, which seems likely, there are complications and good reasons to remain sober. Between now and May 25, when OPEC reconvenes to consider extending the six-month agreement, much more must be done in order to make sure the cuts are fairly distributed, slackers come around, and non-OPEC members stick to the deal. Saudi Energy Minister Khalid al-Falih has his work cut out for him.
Even if OPEC compliance surpasses 100 percent, which seems likely, there are complications and good reasons to remain sober.
At least for the first two months of this deal, the cuts had their desired effect. Prices rose by 20 percent and stabilized in the $50-60 range. Now, however, with a surging U.S. rig count and the global stockpile glut proving extremely stubborn, prices are softening. International benchmarks tumbled to $50 per barrel when $60 per barrel was within reach recently.
So, what’s a kingpin to do?
Despite its status, Saudi Arabia can’t impose its will on those who have agreed to cut or limit supply. Indeed, Riyadh has been burned before by producers who promised to cut and came up short—or cheated outright. OPEC has no way to enforce deals. Saudi Arabia can only appeal to logic, set an example with its own policy, and remind others that it is unique because it can raise production significantly in short order. With that friendly reminder comes the implicit threat that Saudi Arabia is best positioned to fight a price war because it can make up for lower prices with higher volumes. Its competitors have already maxed out production.
Riyadh has been burned before by producers who promised to cut and came up short—or cheated outright. OPEC has no way to enforce deals.
Broken down by country, the compliance data suggest that Saudi Arabia assumed compliance would lag. The Kingdom cut more to be safe and silence the deal’s doubters. On a volume basis, the Saudis agreed to cut by 486 thousand b/d—the most by far—leaving them with a target of 10.058 million b/d. Yet in January they slashed production to 9.946 million b/d and in February they cut again to 9.85 million b/d.
Angola, Ecuador and Kuwait also overachieved in February. This allowed OPEC as a group to achieve a compliance rate of 98.5 percent even though six of the ten OPEC members bound by the deal fell short. Algeria, Qatar and Gabon are closing in on their respective targets while the UAE, Venezuela, and Iraq have to catch up. Beyond OPEC, Russia’s output stayed above 11 million b/d last month, raising questions about its commitment. Ultimately, the Russians are to cut by 300,000 b/d from October levels, representing half of the pledged non-OPEC cuts.
The UAE fell short, which is surprising, because the GCC producers are usually a unified block when dealing with OPEC. However, Riyadh isn’t alarmed. The UAE is saying all the right things. It plans to cut more this month and next so that it will achieve the target if cuts are averaged out over six months. Venezuela is a basket case, to put it mildly, but greater compliance can’t be ruled out either. For what it’s worth, the Venezuelans took a hands-on role organizing and advancing the OPEC/non-OPEC deal last year. They also sit on the five-member monitoring committee which is to review compliance. For these reasons, Venezuela can’t exactly shirk its duties. The country’s oil sector is so desperate that production could fall in the coming months whether officials like it or not.
The Saudis will give Russia the benefit of the doubt because last year Energy Ministers Falih and Novak worked so closely in pursuit of a deal.
Then there’s Russia, without which there would be no OPEC/non-OPEC deal. It was Russian-Saudi oil diplomacy that paved the way for what we might call “Super OPEC.” While OPEC members were expected to curb production starting January 1, Moscow always said it would cut gradually. In this way, it’s no different than Mexico, which is also party to the deal. Russian Energy Minister Alexander Novak has said repeatedly that his target for compliance is end-April/early-May. He says Russia can’t cut sooner because shutting down operations in winter is risky; equipment and infrastructure could be damaged. The Saudis will give Russia the benefit of the doubt because last year Energy Ministers Falih and Novak worked so closely in pursuit of a deal.
Iraq’s lagging compliance is harder to overlook. Five years ago, Iraq eclipsed Iran as OPEC’s number two producer behind Saudi Arabia. Since then, Iraqi production climbed from 2.980 million b/d to 4.6 million b/d at the end of 2016. Iraq was to cut 210 thousand b/d under the November deal, making it the second-largest OPEC contributor.
The problem is that officials and OPEC’s secondary sources disagree on the baseline from which Iraq is to cut. Baghdad put October crude production at 4.75 million b/d, whereas secondary sources put it at 4.56 million b/d. A cut of 210 thousand b/d from official levels would mean Iraq’s target was 4.54 million b/d. But cutting from the secondary source level would knock production down to 4.35 million b/d.
In November, OPEC agreed not to use official data; the OPEC press release announcing the deal cites secondary sources for reference levels. According to Platts, which is one of the secondary sources used by OPEC to judge compliance, Iraqi production was 91 thousand b/d above its quota in February. Initially, Iraq refused to cut, period. The fact that it agreed to cut at all might be more important than achieving 100 percent compliance.
It’s too soon for Saudi Arabia to panic since greater compliance may be forthcoming from those who promised it explicitly and those who said it would happen gradually.
Pushing for greater compliance, if you’re Saudi Arabia, is best done behind closed doors. Naming and shaming simply won’t work. Pulling the rug out from the deal now would be suicide when prices are teetering. Instead, the Kingdom must stay the course until the next OPEC meeting, which is only two months away. It’s also too soon to panic since greater compliance may be forthcoming from those who promised it explicitly and those who said it would happen gradually.
In the meantime, however, Saudi Arabia can keep up the pressure by warning “free riders,” as Energy Minister Falih did this month in Houston. It can also leverage consensus within OPEC to pressure non-compliant members, perhaps more so now that prices look fragile. The idea being: We’re all in this together or it’s every man for himself again. Moreover, Saudi Arabia could remind its peers that it did them a favor in the first place—cutting as much as it did. It could starting pricing its oil more aggressively. It could yet ramp up production by 200+ thousand b/d from February levels and not compromise its quota.