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Oil supply cuts extended

A Russian and Saudi-orchestrated production freeze is to be maintained throughout 2018
December 1, 2017

As expected, the world’s largest oil states flew into Vienna this week, held a few meetings, and eventually extended an output cut agreement that has raised the price of Brent crude by 15 per cent so far in 2017. UK oil shares were largely indifferent to the widely-trailed development, though there were gains for several US energy stocks, whose free cash flows are more reliant on higher-cost shale production.

Failure to extend the deal would have been bearish for listed producers and many of the Opec cartel members in attendance in Vienna. In the end, an existing deal to strike 1.8m barrels from global daily production that was set to end in March has been extended throughout next year. The agreement, which could yet help to incentivise another tsunami of unconventional US output, builds on an existing deal brokered last year by Saudi Arabia and Russia, whose production makes up around a fifth of global supply.

Russia has paid a price for this, namely the influence that would come with the greater market share it desires. It has also extracted a concession, principally the possibility of a “further adjustment” to the cuts in June. If oil prices continue their current trajectory, and US output flat-lines, we would expect Opec’s chief non-Opec sponsor to walk away from the table.

Until then, the agreement’s efficacy will largely be tested by the strength of global demand, the level of recovery from Libya and Nigeria (which were excluded from the cuts), and US production growth.

“There has been good progress this year, but the job isn’t done yet,” said HSBC, shortly after the deal extension. “We expect demand growth to remain healthy in 2018 at comfortably over 1mbd, but also for US tight oil supply to grow by c.1mbd year-on-year. Against this background, an unwinding of OPEC’s cuts would risk leading to inventories rising once more.”

Chris Midgley, head of analytics at S&P Global Platts, added that while weak seasonal demand and higher stocks will put pressure on prices in the first half of 2018, the longer-term picture is more favourable to producers. “Looking beyond next year, we anticipate potential supply tightness as lower investment curtails production growth against continued robust demand,” he said.