OPEC’s new plan

on May 23, 2017 at 12:06 PM

With the cartel’s meeting in Vienna drawing closer by the day the question on everyone’s mind is: “What will OPEC do?” After the Saudi agreement with Russia, it is clear production cuts will be extended and OPEC has only three choices: decrease, maintain, or increase output.

Saudi Arabia Oil Minister Ali al-Nuaimi Press Conference

The goal of OPEC’s production cuts is to reduce the glut of excess inventory on the market, and achieve a level of price stability somewhere above $50 a barrel. If OPEC were to hike production, it could cause a collapse in the price of oil to below $40 a barrel, which would be a disaster for most OPEC nations. This means the only logical courses of action to take are to either extend the cuts at their current level or make the cuts deeper. The difficulty with increasing the depth of the cuts is the economies of most members of OPEC are dependent on oil.

Therefore, while deeper production cuts would deplete the current market supply glut faster, the damage to many of the OPEC member economies would simply be too great for them to tolerate. Additionally, if OPEC fails to supply oil to distributors they will look elsewhere, and after production cuts end new supply contracts will be in place. Making deeper production cuts would mean ceding significant market share to new players in the industry like US shale.

The original production cut was intended to damage the margins of unconventional producers and squeeze refiners. Weaker than expected demand worldwide combined with the production overhang from OPEC members fourth quarter of last year threw a wrench in these plans. The market glut has provided middlemen with plentiful supplies and while OPEC’s plan has by and large kept prices over $50 in 2017, it has not had the desired effect upon the market.

Whether continuing production cuts at this level will have the desired effect remains to be seen, but skeptics would point out the glut is huge, and the US rig count keeps rising.