Alaric Securities celebrates at Nasdaq MarketSite
December 1, 2016

Hangover Awaits as OPEC Celebrates Its Biggest Accord in Years

Alaric Securities
  • Agreement to cut output will work only with self-compliance
  • Unintended consequence: U.S. shale drillers will benefit, too

Let OPEC celebrate. For now.

The oil club is dizzy with its own success after a harmonious meeting in Vienna, where it surprised the world by agreeing to its first production cut in eight years. Oil prices up 10 percent? Check. Saudi Arabia and Iran in agreement? Check. OPEC and Russia working together? Check. After being left for dead, OPEC pulled it off once again.

In hurried notes just hours after the end of the meetings, analysts joined the party. “OPEC resurrection,” Neil Beveridge at Sanford C. Bernstein & Co. called it. “OPEC is back,” opined Martijn Rats of Morgan Stanley. “OPEC in the driver’s seat,” trumpeted Tudor, Pickering, Holt & Co.

Leave it to Abhishek Deshpande of Natixis in London to take away the punch bowl. “OPEC returns,” he said, “but be wary.”

Deshpande, though a party-pooper, is correct that there are many reasons not to get too delirious about the agreement to curtail output by 1.2 million barrels a day, the most prominent being the cheating of OPEC’s own members.

But for now, an industry that’s endured the most painful downturn in a generation is too busy clinking glasses to the latest from the S&P 500 Energy Sector Index, which surged Wednesday more than 5 percent to its highest in a year and a half. And the bubbly will flow to mark the end of belt-tightening for behemoths such as Exxon Mobil Corp. and Total SA. If all goes well, projects of theirs that were delayed only months ago could be approved soon.

Negotiated Peace

It’s the Organization of Petroleum Exporting Countries itself that will benefit most from the negotiated peace. Amrita Sen, chief oil analyst at Energy Aspects Ltd. in London, said that “even allowing for some cheating” the deal will turn an expected increase in inventory in the first half of 2017 into the opposite. That, in turn, should push up oil prices. OPEC officials have expressed the hope that by midnight on the last day of 2016, oil will be approaching $60 a barrel. That would be a reason for another round of toasts and a happy outlook for the new year, considering that last January, oil was wallowing below $30 a barrel.

Now for the “be wary” part. For all its success in Vienna, OPEC is far from resolving its lingering problems. For one, the agreement depends on self-compliance, and the commitment to cut from key countries, particularly Iraq, is weak. Iran, which was allowed a production increase but agreed to cap it at 90,000 barrels a day, is also showing signs it could go rogue.

“Disagreements persist among OPEC members on how to measure production, so the deal will be hard to police,” said Spencer Welch, a director at consultant IHS Energy.

Promises Kept

Saudi Arabia and its Persian Gulf allies, the United Arab Emirates and Kuwait, have traditionally stuck to their promises to cut. But others haven’t, particularly when prices are low. Skeptical traders believe that after a couple months of cuts, cash-strapped Venezuela and Angola will be boosting production to cash in on higher prices.

Libya and Nigeria are exempt from the OPEC deal because they’re still trying to recover from previous outages. As their production rises, they may make it tougher to comply. OPEC will review the situation in late May.

Reductions by non-OPEC countries such as Russia and Mexico, which agreed to cut nearly 500,000 barrels a day, look more like production freezes and natural declines rather than genuine voluntary compliance.

Higher oil prices could also weaken demand growth in 2017, muting the benefits of lower production. And global inventories are at record levels. As prices rise, traders will slowly release stocks, dampening the agreement’s intended effects.

Winner: Shale

And in a classic case of an unintended consequence, a surprise winner could be OPEC’s nemesis: U.S. shale.

American producers, whose destruction OPEC tried to hasten with its “pump-at-will” policy in late 2014, are poised to flourish. Already, Continental Resources Inc., the company founded by Donald Trump adviser Harold Hamm, gained as much as 25 percent on Wednesday, the most since 2008, a time when oil, at $150 a barrel, cost approximately three times what it does today.

When OPEC first announced its intention to cut in late September, U.S. firms used the price rally to lock in 2017 and 2018 revenues by hedging. Energy bankers and oil traders expect the same hedging this time. In effect, OPEC could end up throwing a lifeline to the producers it vowed to defeat two years ago.

“Assuming OPEC makes good on an apparent production-cut deal, U.S. oil production growth is all but guaranteed to return in 2017,” said Joseph Triepke, founder of Infill Thinking, a Dallas-based oil-research firm.

Some OPEC officials worry this week’s agreement could become a Pyrrhic victory if resurgent U.S. production gobbles up market share from the likes of Saudi Arabia, Algeria and others. But now is no time for concern. Most industry executives agree that the accord means OPEC has staged a comeback worthy of celebrating.

Even if it’s U.S. shale’s party, too.

Article and media originally published by Javier Blas at