On Wednesday OPEC agreed to curtail its oil supply, the first cut in nearly eight years. The decision to cut is the first significant intervention to support price since 2008 and is likely to result in a much quicker market re-balancing, which may be further accelerated by the agreement with non-OPEC participants. Russia has already publicly indicated it is ready to cut production in the first half of 2017 by up to 300 thousand barrels of oil per day (mbpd), although it is not completely clear from which level production will be cut. OPEC says that non-OPEC producers have agreed to cut output by 600 mbpd, which would mean a total cut of 1.8 mmbpd, almost 2% of global output.
The OPEC commitment alone could end market oversupply, and should result in a gradual decrease in OECD oil stocks throughout 2017. Using IEA forecasts as an input, we estimate that crude consumption may exceed production by around 400mbpd in 1Q17 and 1,300mbpd in 4Q17 if the deal is extended and the new OPEC quotas are respected; the difference may be even higher if non-OPEC members join the deal. Without the deal, stocks, which we estimate to be around 300 million barrels above their five-year average, would more likely remain flat.
But significant risk remains that OPEC members will produce crude above quotas, as has happened in the past. This could slow market re-balancing. Another unknown is how quickly the US short-cycle crude production will react to higher oil prices. US shale production has already begun to bounce back from recent lows, and may accelerate at prices above USD50. In addition, the deal is for six months, and there is no guarantee OPEC members will reach a consensus to extend it. These factors mean our gradual oil recovery scenario remains a valid conservative assumption, although the stress case, assuming oil retreating below USD40/bbl, is now much less probable.
The deal has not changed our view on long-term oil prices, which we believe are more driven by the marginal cost of supply. Costs vary enormously over time, with geology, geography, engineering solutions, and the demand-supply balance in services markets major contributors. Our latest full-cycle costs research suggests that $ 65 is a reasonable estimate.