source: Stock Photo
One of the first things I thought of when looking over the production cut deal with OPEC, Russia and others, was the difficulties Russia faces in being able to practically abide by the conditions of the agreement.
Another major factor was how much oil shale producers will quickly bring to the market in response to the vacuum left by the participants in the cut. Along with that are several other countries which have goals of increasing production in 2017, which when combined, should add another 500,000 barrels per day, at minimum, to the supply total.
For that reason the assumptions and assertions this will lead to a rebalancing of the oil market is far too premature; it's more positive thinking at this time than based in fact.
Depending on how much more supply will be added to the market in the months ahead, it will determine whether or not this deal will be able to hold together, or if it is nothing more than words on a piece of paper. Media reports, for the most part, have already acted as if this is a done deal that will be adhered to. That has yet to be proven.
What investors will get out of the deal has already happened, and there is little more to get excited about now that the expected jump in oil prices has occurred. They will pull back to around $50 per barrel after the emotion dies down.
From there, once the market starts to see the cut can't and won't have the type of impact it has in the past, we could see it dip and hold in the $48 to $49 range.
The first step will be to see what Russia has to say when it meets together with other participants in the deal in about a week. Since everything in the deal was largely in response to concerns aired by those watching the progress and process leading up to the decision, it's very questionable concerning a deal that appears to be so perfect can even be implemented, assuming those making the cuts are being truthful in their intentions.
The biggest immediate problem to me concerning this deal is Russia. While it has agreed to cut about 300,000 barrels per day from its output, the question is where will it be able to find places to make that hefty of a cut, assuming it really wants to.
Most obvious is the nature of the technology and methodology side of its production. Because the bulk of its production is in regions with freezing temperatures, it isn't able to just switch off production. Even if it tried, it could result in damage that could take a long time to fix.
Some true believers are pointing to the oil giant allowing older fields that don't have as much value to the country being shuttered, but I doubt Russia's just going to let declining fields lose most, if not all of their value, because of this deal.
From the beginning of including Russia in the deal, I was and remain extremely skeptical. The question is whether or not Russia, no matter what it wants to do, is able to deliver on its promised cuts. I don't believe it can, and early reports have it possibly lowering some production at incremental levels for several months.
The problem is that Russia's involvement is temporary, and the original deal is for a six-month period of time. What will Russia really have to cut leading up to the end of the agreement? It doesn't look like much at all.
For that reason I don't consider Russia a real factor in this deal. It will continue to be reported as vital in the media, but there will have to be complete proof of compliance before I would conclude it has even cut back on one barrel of oil being produced.
U.S. shale industry will continue ramping up
The general consensus at this time is that U.S. shale producers will be only able to add about 200,000 more barrels per oil a day with the wells they now have available to complete. I think that's nothing more than a guess.
My reasoning for drawing that conclusion is we simply have no idea how productive these premium wells will be, as the market has never been in this place before. Almost every time the market has drawn conclusions concerning shale, it has underestimated it concerning efficiencies and productivity. I see nothing to suggest that won't be the same going forward.
What's most important to me is U.S. shale producers were increasing production, not because of the possibility that OPEC would cut production, but because they've taken so much of the costs out of the production process, the new wells can generate a profit when oil is at these prices.
When I say U.S. shale here, I'm referring to the top companies, not all the producers, some of which can't compete even with oil where it's at now.
The highest quality shale producers don't need a production cut to compete. They're transitioning from their portfolios being dominated by high-cost legacy wells, to recently completed premium wells. Once that transition is made, they will be able to produce at whatever level they choose to, within the parameters of their reserves.
Producers not being considered by the market
While we can quibble about how much oil will be supplied from U.S. shale producers over the next year, the sector is a known part of the overall picture, and in general has already been priced in.
In my opinion from keeping my ear to the ground, what hasn't been priced in or considered by many is the other non-OPEC members that will continue to boost supply in the months ahead. The most important of those are Canada, Brazil and Kazakhstan.
Together with the remaining producers outside of OPEC, this should add a minimum of 500,000 barrels more to the market. I believe there's a chance it could be even higher, based upon by analysis on U.S. shale producers mentioned above, and possibly a more aggressive production level from the three countries above.
If Libya and Nigeria are able to consistently improve supply levels, the entire oil market looks ready to raise oil supply to very challenging levels in 2017. To compare to 2016, the total oil from non-OPEC producers declined by 900,000 barrels per day.
Assuming these figures are close to being accurate, which they are, it would mean 2017, even with the oil cut agreement, and assuming it holds, will be awash with oil.
That once again brings me to whether or not this deal will hold together very long when competitors start taking market share away from OPEC in general, and Saudi Arabia and Russia in particular, once again assuming Russia is even able to slightly comply with its promises.
Of major importance to the production cut has been the acceleration of rebalancing the market. Part of that stems from expectations ongoing increase in demand, even though the pace is slowing down because of weakening economies.
The question now is whether or not the soaring supply levels from non-OPEC members will be so robust as to make the output cut irrelevant. I understand it can be argued it would be a lot worse without a deal, and I agree, at least in the short term.
What makes it more of a problem is there is no way OPEC, Russia or any others will continue to cede market share if once again shale producers and others continue to keep production levels growing and high.
The U.S., Canada, Brazil and Kazakhstan aren't going to cut back on production, and neither is Indonesia, which left OPEC over that very matter, less than a year after rejoining it.
As I've been saying for some time, this is the last hurrah for OPEC. It has slowed down the U.S. shale industry enough to buy it a little time to support oil prices by making cuts. It no longer has the ability to do that over the long term, as the market is going to find out; I don't care how many old school pundits and analysts they roll out to say different.
All that's left to be decided from my point of view is how much time OPEC has in fact bought, and how quickly it'll have to reverse its course when oil comes flooding the market from its competitors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.