Opinion: Opec faces tough choice on extending output cuts

If an extension of existing production curbs were to lead to a renewed and sustained spike in the crude price, that could begin to hit the world economy

PUBLISHED : Tuesday, 02 May, 2017, 8:46am
UPDATED : Tuesday, 02 May, 2017, 10:39pm

The Organisation of Petroleum Exporting Countries (OPEC) will convene on May 25 to decide whether to extend the lifespan of production cuts agreed in December. It is a big decision for OPEC and indeed for non-OPEC nations who also signed up to the curbs, and it is not clear-cut.

Higher oil prices, by providing an inflationary impulse to prices, act as a tax on the world’s consumers but currently the International Monetary Fund is positive on the prospects for the global economy, and predicts world growth will rise by 3.5 per cent in 2017, and 3.6 per cent in 2018, compared with last year’s 3.1 per cent increase.

If an extension of the existing production curbs were to lead to a renewed and sustained spike in the price of crude, then that could begin to hit the world economy.

But such an extension would also mean that participating oil producers would have to start making real cuts in output. It could be argued that December’s agreed output curbs correlated with normal seasonal production downturns and so didn’t really represent material financial sacrifices.

Saudi Arabia might have agreed an output cut that began in December, but peak Saudi production normally occurs during its summer months to satisfy domestic demand for crude oil for electricity generation as well as to fulfil its international commitments.

Riyadh would likely have been trimming production to some extent anyway even without the formal agreement made at the end of last year.

If the production curbs are now extended into months where Saudi Arabia would ordinarily be ramping up production, then that would be a sign that Riyadh really means business.

Russian oil production also tails off during the Siberian winter before increasing as the weather improves. Russia’s Energy Minister, Alexander Novak, said on Friday that Russia is now almost compliant with its current production cut commitment.

If Moscow is prepared to extend the time frame for production cuts, when it would usually be raising output, then it too will be showing it is serious.

All OPEC and non-OPEC signatories to the December production cut agreement would probably agree that the accord has had some success, but equally cannot have failed to notice that other producers, not bound by the accord, have also profited from the arrangement.

PetroChina, China’s largest producer of oil and gas, may have seen a slump in oil production in the first quarter of 2017 but booked a profit on the period. China’s Sinopec saw its first quarter net income rise even though its own production fell. The higher oil price did both companies a huge favour.

Even Britain has benefited as China has dramatically increased its purchases of North Sea oil in the first quarter of 2017, compared to the same three months of last year, as a side effect of the OPEC production cuts.

OPEC’s production cuts have focused more on medium-grade crudes rather than the more expensive lighter oil. Consequently the premium usually paid for North Sea Brent, a yardstick for many of the world’s lighter crudes, has dropped against the Dubai benchmark which is a marker for the price of much of the medium and heavier crude emanating from the Middle East.

In fact, China customs data for March showed the cost of importing a barrel of British crude into China at US$56.70, compared with US$57.80 for a barrel from the United Arab Emirates.

Britain has benefited as data produced by Thomson Reuters Eikon has shown China imported some 38 million barrels of North Sea oil from the start of 2017 to late April, compared with 8 million in the same period in 2016.

Then there’s the United States whose own oil producers are not party to December’s agreement but have benefited from it. Stabilisation of the oil price at around US$50 a barrel has helped US shale oil producers and the banks that have been lending to that industry.

On Friday, both of the US’ largest oil producers, ExxonMobil and Chevron, announced sharp increases in earnings for the first quarter and indicated their intention of investing more in US shale oilfields.

If the extraction price is economic, the more oil the United States can produce at home, the better it is for domestic economic prospects and the less the US dependency on imported energy.

As pushing oil output cuts further into 2017 will mean OPEC and its fellow-travelers actually making real sacrifices, while others continue to profit from the situation, an extension of the current accord should not yet be seen as certain.