OPEC's celebrated and unexpected deal has papered over the market's cracks

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OPEC oil producers press conference
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The outcome of the Vienna meeting came as a pleasant surprise to oil markets.

A deal had been hammered out and, despite the resistance, OPEC and Non-OPEC producers had agreed to cut a total of 1.8mbpd. Saudi Arabia − suffering from a major dent in its economy− has agreed to the largest cut.

OPEC producers will, overall, cut a total of 1.2mbpd and Non-OPEC producers will shed 0.6 mbpd of their production, of which Russia is ready to contribute 0.3 mbpd. And there are still more meetings to come, the first this month and the second in May 2017, both of which will aim to ensure members follow through on the deal.

While this sounds very positive for oil markets, the agreement remains far from a sure thing. Global oil markets have been inevitably transformed by the market share war that has raged for the last two years, as Saudi Arabia attempted to keep North America’s high cost producers out of business. But this strategy went awry. U.S. producers – including the oil majors and many independents − have learned to adapt.

The plunge in global crude oil prices has devastated the North America energy sector, resulting in severe stress on E&P and oilfield service companies, particularly in the U.S. states of Texas and Oklahoma. The economic impact – companies’ steep job cuts, steeper budget cuts, and reduced drilling activity – has strained local states’ fiscal budgets, despite the overall national economy remaining stable.

According to Rex Stoner, a U.S.-based energy consultant, an unexpected consequence of this strain is that U.S. oil & gas companies are innovating production techniques at break-neck speed to keep production profitable despite depressed global commodity prices. The break-even point for U.S. producers was $70 per barrel two to three years ago; today producers will return a profit at half that figure where production is kept constant.

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U.S. volumes have remained constrained by OPEC production however, with a wave of profit taking and optimism on the day the deal was announced. The prices even touched 16 month highs of $55 per barrel. But so far, no concrete steps to cap or reduce production have been taken. The deal has only been agreed on paper and, given the chequered history of Saudi Arabia and other OPEC members in their commitment to past agreements, there are many sceptics.

One of the major reasons is the vicious cycle triggered by the price rise. As soon as global crude prices rose, Baker and Hughes reported a rise in the U.S. land rig count once. The total number of rigs now stands at 597. If the deal holds, and if prices are expected to rise, U.S. shale producers will have an incentive to pump more oil from the ground.

With demand low from China and India, as the IEA also reported in its Oil Market Report, this oil has nowhere to go except to add to the oil glut. Analysts at Oxford also say the same. If this happens then the prices will be drawn down again and the benefits of a production deal will be unclear.

The Eagle Ford play in Texas has posted an increase from 1,280 barrels per day to 1,307 barrels per day. And, as the rig-count has dwindled over the past two years, the new-well oil production per rig has increased. This is also the case of Colorado’s Niobrara play, which has added 35 barrels per day over a month. The November oil drilling productivity report has shown positive gains for the West Texas Permian region while the Bakken play has posted gains as well.

According to the report released in the middle of November, the total number of Drilled but Uncompleted (DUC) wells is 5,155. These wells are half drilled and it is only a matter of time until they start producing oil once again. Furthermore, the Trump administration is expected to adopt friendly policies toward the U.S. oil & gas industry. This will further help the U.S. Shale producers as Trump plans to slash restrictions and allow pipelines to be built that were opposed by the Obama administration.

Another concern for the oil deal is the recent news that OPEC’s production has risen to another high, setting a new record at 33.82 million barrels per day. Also, Russia has recorded a daily production of 11.21mbpd− the highest in 30 years.

This amounts to almost half of global production. Most of this new production comes from producers that have been exempted from the deal, one of which is Libya, which aims to increase its production to 900,000 bpd by next year. Saudi Arabia has also offered Arab light crude to Asian markets at a discounted price in an attempt to maintain the market share. The production at Kashagan oil field has also started and is expected to increase production at the start of 2017.

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The UK’s Daily Mail reported before the deal was struck that the U.S. oil majors − Occidental Petroleum Corp, Chevron Corp, Pioneer Natural Resources Co and ConocoPhillips − are planning to add further rigs. Oasis petroleum Inc. has said that it plans to buy 55,000 acres of land for about $785 million. U.S. unconventional shale oil production is expected to rebound 11 percent in 2018, according to data from the U.S. Energy Information Administration.

Many of the U.S. shale producers are also very confident of the future as they are backed by technological advancements. According to Joseph Triepke, founder of Infill Thinking, the U.S. can add 150 rigs “in the Permian basin alone”.

While the deal was good enough to stir the markets, invigorate investors and appease the concerns of producers, it is still unclear if it has the potential to hold the markets in this state in the longer term. ‘Demand’ is the only market force that can truly save the oil glut.

This article originally appeared on OilPrice.com

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