OPEC supply cuts appear to have failed ahead of meeting

Deepening output cuts may spark rally but encourage bigger flow from US shale

Opec and Russia's plan to clear the global oil glut has not worked as they hoped, but there is little expectation the world's largest producers will act more aggressively when they meet this weekend.

Oil has slumped into a bear market and inventories remain stubbornly high despite a deal between Opec and 10 countries outside the group to cut output. The implementation of supply curbs is faltering as Libya and Nigeria restore lost production.

The trouble for ministers meeting in St Petersburg to review the progress of the deal is the alternatives look little better than the status quo.

If the Organisation of Petroleum Exporting Countries abandons the deal and increases oil output, a further plunge in prices would inflict more pain on their economies.


And while deepening the production cuts would spark a rally, that might encourage even bigger flows from US shale drillers.

"They're between a rock and a hard place," said Mike Wittner, head of oil market research at Societe Generale in New York. "The bottom line is, it hasn't worked" and "if they cut more, the more they support prices, the more they support US production."

Prices fall back

Oil prices have given up all their gains since Opec and Russia assembled a coalition of producers in December to try and end the market's two-and-a-half-year slump.

Despite forecasts that the measures would reduce the world's bloated oil inventories, that doesn't seem to be happening, the International Energy Agency said on July 13th.

US West Texas Intermediate futures were at $46.94 a barrel at 12:14pm Singapore time, while Brent crude, the benchmark for more than half the world's oil, traded at $49.34 a barrel. Both are still more than 50 per cent below their 2014 peak.

The agreement between Opec and its allies was undermined before it even started, as key producers such as Saudi Arabia, Russia and Iraq ramped up exports just before the deadline to cut output took effect.

The pact faces a further challenge as Nigeria and Libya, which were exempt from cuts while they tackled political crises, recover output.

"The underlying problem is Libya and Nigeria combining to produce significantly more than anyone anticipated they would," said Ed Morse, head of commodities research at Citigroup in New York.

Weakening Compliance

While both nations have been invited to the St Petersburg gathering, neither would be willing to reduce supplies even if they were asked, Morse said.

Moreover, as both producers are near the limits of their capacity, any agreement to cap at current levels would merely be symbolic, he said.

Weakening compliance among other nations poses another challenge. Implementation by Iraq - which says it should not have been asked to cut while suffering so much economic hardship and battling Islamic State jihadists - has fallen to a low of 29 per cent, according to the Paris-based IEA.

Ecuador's oil minister Carlos Perez said on Monday that his country was pulling out of the deal, before diluting those comments the following day.

The failure of the accord is driving Saudi Arabia to consider taking extra steps by itself, according to a report by consultants Petroleum Policy Intelligence, citing information from “key players” in Opec.

The kingdom’s exports would probably drop by 600,000 barrels a day this summer as local demand peaks, and it may deepen the reduction to 1 million a day, it said.

“Opec has grown a bit weary of the negative sentiment, and Libya and Nigeria have made it impossible to get inventories down to the five-year average,” said Bill Farren-Price, founder of UK-based PPI. “We think they’re looking at options to speed up the rebalancing.”

- Bloomberg