Oil: Real challenge is the implementation of the oil agreement - BBH

Research Team at BBH suggests that although an agreement within OPEC and also between OPEC and non-OPEC producers was struck, the real challenge is the enforcement, as no such mechanism exists.  

Key Quotes

“While everyone is well aware of that, our point is that sequence is important and it is too early to worry about violations.” 

“Like many, we seem to have underestimated the Saudi's resolve.  Shortly after securing an agreement from non-OPEC members to cut output, Saudi Arabia indicated it was prepared to cut output more than agreed last week.  It suggested it would cut output below the psychologically important 10 mln bpd threshold.  Not only is OPEC not dead, but Saudi Arabia's leadership is significant.  Although non-OPEC members will cut 558k barrels, less than the 600k asked for, it is still the most ever.  It is also impressive, that despite Kazakhstan’s new large oil field coming on line, it also participated by a small cut (20k bpd).”

“The optics are good and this will likely lift oil prices further.  Over the coming months, we suspect there is scope for oil to rise to $57-$65 a barrel basis on the January futures contract.  That said, the closer one examines the details, the less impressive it looks.  Consider Russia will account for 300k bpd reduction, more than half of the non-OPEC contribution.  Russia had boosted its output in recent months as an agreement was distinct, even if unlikely, possibility.  There was a post-Soviet Union record 11.247 mln bpd in October.  It says that it will cut 200k barrels by March and another 100k bpd in six months.”

“Saudi Arabia's agreement with OPEC should bring its output back to its average earlier this year.  Several other countries, including Mexico, are simply formalizing a natural decline.  Important non-OPEC producers, including those in the US, Canada, and Brazil will be the beneficiaries, as free-riders.  US capacity, especially the shale component, is very flexible and there are reports of that many wells have been drilled, but the wells have been capped.  Consider it a free natural underground storage facility.”

“Also, recall that important technological advances have been made over the past two and half years (yes, Professor Gordon, the innovations are not as significant as the internal combustion engine) that lowers the cost of getting that marginal barrel of shale.  Assuming that some US producers are skeptical of the implementation of the oil agreement, there may be incentives to boost output quickly to take maximum advantage of what could be a small window of opportunity.”