OPEC: Who Cut, Who Did Not?
November 26, 2017
Comparing OPEC members’ crude oil production in October 2017 to production in October 2016 (before the agreement of production cut), is not the best way to show who has cut production and who has not, but it provides a glimpse into the cut. One fact is clear: Saudi Arabia made the largest cut. Other Gulf states also cut proportionally. Another fact (but details are not shown on the chart), the Iraqi and the Venezuelan cuts were involuntary. Iraq crude oil production declined in October because of the Kirkuk/ Kurdistan issues. Venezuela’s production has been declining for several months because of various financial, technological, and political issues. However I strongly believe that Venezuela would have had cut production in normal circumstances in accordance with OPEC agreement. But this fact does not matter anymore.
Where is OPEC’s cut?
Several people questioned OPEC cut: Production has NOT declined! While they are correct in reading the data, their interpretation is NOT correct.
The green area in Figure (2) shows OPEC actual production. If you compare production in recent months to production in January, you can see easily that OPEC production has increased. But the comparison should be between current production and where would OPEC production be without the cut: the cut is actually about 1 mb/d as shown in the orange area. The orange area is NOT a lost capacity. It is still alive and well.
Here is an interesting question: what would the oil price be today if OPEC and non-OPEC has never agreed on a production cut? While it is hard to answer this question precisely, several facts are clear:
- OPEC production would have been higher than actual, but how high is debatable. The maximum is about 1.1 mb/d.
- Growth of shale would have been way lower, and could be negative. (continuing the decline of the 2016 and probably in accordance with earlier forecasts by the EIA and IEA that expected a decline in shale production in 2017)
- Growth in non-OPEC production would have been lower.
I did several simulations. One of the most interesting results is that oil prices would have been virtually the same, with cut or without cut, by yearend! So, what is the advantage of the cut then?
There are numerous advantages to the Saudi led production cut, here are some:
- The production cut, led by Saudi Arabia, did not only save the global oil industry from a total collapse (including that of Saudi Arabia and its economy), but also saved several US shale companies from bankruptcy. Without talks of cut and then the cut, $25-$35 oil prices would have lasted way longer. Now just imagine the impact if prices in the range of $25-$35 persisted for an additional 4-5 months. Think of balance sheets, cash flow, rigs, completions, workers, and all the forward and backward linkages of the industry.
Some people might argue that prices would have settled around the low $40s, which is the marginal cost of shale is. Therefore, the argument above about $25-$35 range does not apply. In theory, they are correct in a competitive market and in manufacturing in particular. It does not apply in an extractive industry where the market is not competitive with most of the cost is sunk cost. In this case, prices can decline to any level.
- Without production cut, global spare capacity would have been minimal, at best. Any political crisis even in a remote oil-producing area, would send shock waves throughout the global economy.
- Production cut brought stability to the oil markets. Just imagine, without cut, we would go from one extreme of low oil prices to another extreme of very high oil prices. Then the cycle will start all over again. This relative stability that the cut brought is good for everyone, including consumers and shale producers.
- While production cut restored the legitimacy of Saudi Arabia as the swing producer. It also restored OPEC reputation and enabled OPEC to function properly, despite all the misgivings about OPEC behavior. Production cut enabled OPEC in general and the Saudis in particular to finally convince a large number of non-OPEC producers to join the agreement.
Worth noting here, whether these countries cut or not is not an issue. Their contribution would have been minimal anyway. But from a strategic and diplomatic point of view, it was a great success. Those who are against OPEC now, by default, are against most of the global oil industry. It is no longer about people of certain color, political affiliation, or certain religious belief. Got it?
Bottom Line: The production cut is real and has paid off and will continue to pay off, not only for the Saudis and OPEC members, but also for shale producers.