As many commentators note, a 1,2 mbpd oil output cut as agreed by OPEC may not be enough to wipe off the surplus of oil at the global markets, let alone the concerns about the discipline of the cartel members in abiding to agreed cuts (http://www.reuters.com/article/us-opec-oil-asia-idUSKBN13Q40K). In this regard, announced participation in the cuts by non-OPEC suppliers by 600 kbpd becomes crucial, and all eyes are on Russia in the first place, which is supposed to take the biggest share of the non-OPEC cut (300 kpbd).
Leaving aside the issue of who these “other producing countries” besides Russia will be, and the question of whether they will be willing/capable of cutting output (Kazakhstan had just introduced the giant Kashagan field onstream, Mexico is struggling with oil output decline by trying hard to stimulate production growth by foreign investors), let’s just focus on whether Russia will be actually able to deliver the cut.
First, Russian chief negotiator, Energy Minister Alexandr Novak, have delivered mixed signals as to what exactly Russia is promising. While talking to the media, he used two phrases which are in contradiction with OPEC’s desire to achieve output cut in January: “gradual cut” and “cut versus planned output”. No one knows for sure what “gradual” means, but given the fact that 300 kbpd is not an overwhelming supply cut in itself (Azeri oil Minister Nariq Aliyev has confessed that OPEC have asked for nearly 900 kpbd cut from non-OPEC states), its extension to a longer-term period may eliminate the January supply wipe-off effect that OPEC is aiming at. And the oil prices have already rebound to the level far more comfortable for the U.S. shale producers to drill more ($54-55). Which means that, if the Russian cuts will be “too gradual”, they will have a little or no effect in the coming months, particularly against some new American volumes potentially entering the market.
Another vague formula is “cut versus planned output”. OPEC clearly wants cuts compared to current levels, literally wiping some of the volumes off the market. “Cuts to planned level” can be anything – depends on what “plan” Russians had in mind. In theory, it may even turn out to be exactly 300 kbpd higher than current levels. Recently, Russia has been pumping increasingly more: in December, the country’s output will likely exceed September levels by over 110 kbpd.
Second, there was never a mechanism in Russia to distribute specific supply cuts among oil companies, monitor compliance, and hold them accountable. Just to mention that a field-based differentiation system for mineral extraction tax was rejected by the Government years ago partly on the basis of the fact that field-by-field output accounting system is non-existent. Yes, there is aggregate data on production by company, but options for cheating are immense, particularly if no financial sanctions are in place for non-compliance.
Russian companies have already said that they don’t want to cut production – so was the recent position by heads of state-owned Rosneft (http://www.rbc.ru/rbcfreenews/57fcc46e9a79479f03499497) and Gazprom-neft (https://ria.ru/economy/20161001/1478287781.html), and biggest private player, Lukoil, has asked for financial compensations from state in return to possible production cuts (http://www.rbc.ru/business/02/12/2016/5841656a9a7947fa299dd7b7). Some may say: but in modern Russia Putin’s word is the law, and if he orders something, you better obey. Well, that’s not necessarily the case: for instance, a famous comprehensive set of Putin’s orders to ensure independent gas producers’ access to Gazprom pipelines issued at the meeting of Presidential Commission on energy affairs 1,5 years ago (http://kremlin.ru/events/councils/by-council/29/45831) was almost 100% ignored in the end, and no access provided.
It shall be also reminded that obligations to reduce oil production were already taken by Russia under Putin – in late 2001, Russia pledged to OPEC to reduce output by 150 kbpd in 2002 (http://izvestia.ru/news/255575). In reality, Russia had, instead, raised output by 650 kbpd in 2002. Current situation is different: matured oil fields are in depleted stage and many of them already are in decline, and recent growth was delivered only by a handful of new projects recently brought onstream. However, there’s a number of new fields still able to deliver extra volumes in the short term, and it is those who may fall victim of the Russia-OPEC deal and be delayed. This will cost money to companies, which is why the issue of compensations from state had surfaced in public.
Anyway, the mechanism needed to reach an agreement with Russian companies on volume distribution for potential cuts, and for compliance monitoring and imposing penalties, is just not there, and developing and implementing it would be a difficult deal. It’s one thing for Putin to yell “Do as I say”, but his 17 years in power have been plagued by inability to make complex mechanisms work – which is why the overly centralized bureaucratic system have been leaning toward primitive solutions (the above mentioned flat mineral extraction tax system is just one relevant example for the oil industry). This is why I personally don’t believe in Russia significantly cutting oil production soon as a result of deal with OPEC – and which means that OPEC efforts would end up being insufficient and not influencing the oil market much.
Update: After this text was released, the non-OPEC oil producing countries have signed an “agreement”, which further confirms skepticism about the producers’ ability to significantly cut output:
- ▪ Contrary to OPEC November request to cut 880 kpbd, and to recently widely mentioned figure of 600 kpbd, non-OPEC producers “pledged” only 558 kbpd of cuts;
- ▪ Lion’s share of this figure is pledged by Russia (300 kbpd) and Mexico (100 kbpd), whereas the rest is scraped by small bits among less important producers and will be hard to control;
- ▪ Mexico’s promised “cut” is somewhat tricky, as its supply is in constant downward trend, and was expected to decline by over 100 kbpd anyway in second quarter of 2017 as compared to third quarter of 2016, according to International Energy Agency projections;
- ▪ Russia, as it is now revealed, has “pledged” to cut the output by 300 kbpd not at once in January, as OPEC had initially hoped, but very gradually – by 200 kbpd by the end of first quarter of 2017, and by another 100 kbpd some time by the Summer.
This means that the idea of a coordinated January cut that OPEC had hoped to agree with non-cartel producers is just not working out – the overall “pledge” by non-OPEC members is well below the volume that was initially thought of, and too disperse to expect discipline and full compliance. Much more confidence now that all these “cuts” will have little actual effect on the market.