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January 23, 2017
OPEC production cut: Genuine boon or flash in the pan?
By: Muqsit Ashraf and Manas Satapathy

Will announced cuts in crude production launch an upcycle such as those seen in the 1970s and early 2000s? Or, will the market more closely resemble the lagging prices of the mid-‘80s through the turn of the century (Figure 1)?

Figure 1. OPEC power relevant in tight markets.

Figure 1. OPEC power relevant in tight markets.

Source: BP statistical review, Accenture Strategy analysis. 

For roughly 24 months, supply has exceeded demand by 1 to 1.5 million barrels per day (bpd), boosting inventory to nearly 3.0 billion barrels globally. Assuming a third of the inventory is non-strategic, 1 billion barrels could absorb a supply shortage of 1 million bpd for over 30 months1.

Last year's capital expenditures dropped under $400 billion (versus $654 billion in 2014), which would have had a greater impact on driving down excess supply had oil prices stayed low. With oil prices above $50, however, capex is projected to grow, particularly in North America, West Africa and South America2.

The announced cuts by the Organization of Petroleum Exporting Countries (OPEC) are likely to make a difference, but not enough, or for long enough, to launch a bull market. Three reasons:

  1. Slippage: OPEC countries are known to not adhere to the contractual terms. Overproduction historically has ranged from 0.6 to 1.9 million bpd. Combined with the headroom for Iran of 0.3-0.4 million bpd, this is expected to be at least 0.4 million bpd3. If anything, the incentive to produce more than allowed will be higher to take advantage of higher prices while they last (Figure 2).

Figure 2. Forecast of supply/demand in next 12 months.

Figure 2. Forecast of supply/demand in next 12 months.

Note: LTO Growth does not look at well economics; Slippage implies non adherence to committed cuts.
Source: EIA, Accenture Strategy Hydrocarbon Supply Model, Accenture Strategy analysis.

  1. Light tight oil (LTO) production: Low prices, reduced capacity and a run-up in supply chain costs constrained LTO in the United States. But consider the massive reserves in the Permian basin, a large inventory [4,500] of drilled uncompleted wells, and renewed investments demonstrated by rising acreage prices. Net result? LTO production in 12 months is likely to exceed the peak of 20154.
  1. Price elasticity: Demand reductions typically lag rising prices. Along with rising demand due to lower crude prices, however, we expect a decrease in demand, estimated at 0.1 mil bpd, due to higher prices5.

Without deeper cuts from OPEC and non-OPEC players, the supply glut is likely to reemerge in the second half of 2017.

Are happier times a distant dream? Not quite. As in other markets, supply and demand forces will play out. Players will have to adjust to volatility and restrained prices. Winners will be rigorous in developing assets that are economically superior and better suited to their internal capabilities. They also will be agile in aligning capital spend with market cycles, and be more inclined to invest in projects with a front-loaded (or lower-risk) cash flow profile.



Footnotes

1 IEA 2014-2015 monthly reports; Accenture Strategy Hydrocarbon Supply Model
2 “E&P spending to rise 7.3 percent in 2017: Barclays”, Petroleum Argus, 10 Jan 2017, Copyright © 2017 Argus Media Ltd - www.argusmedia.com, via Factiva
3 “OPEC Spat Over Production Data Grows as Iran Rejects Estimates”, Bloomberg, October 17, 2016, © 2017 Bloomberg L.P, via Factiva
4 Accenture Strategy Hydrocarbon Supply Model. The Accenture Strategy Hydrocarbon Supply Model includes data from sources such as the IEA Oil Market Reports, the EIA Short Term Energy Outlook, Rystad Data and Wood Mackenzie’s Upstream Data Tool.
5 Ibid.

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