Liquid Black Gold: Time to Shut the Tap?

The lingering oversupply in the crude oil market which led to a more than 50.0% plunge in global crude oil prices (from over US$100/b in July 2014 to less than US$50/b in 2016) and worsened fiscal and external sector profiles of major oil exporters finally forced some actions from members of the Organization of Petroleum Exporting Countries (OPEC) this week. This episode of lower oil prices stemmed from the unrelenting struggle for market share between OPEC members and Shale oil producers (in North America) which drove excess supply to an estimated 2.1mb/d in 2015 and 1.2mb/d in Q2:2016 according to data from OPEC.

Despite the obvious socio-economic impact of the glut on oil exporting countries, OPEC members who typically play a balancing role in the market, have been unable to reach a consensus as regards capping production levels. This is partly due to the geopolitical tussle between Iran and Saudi Arabia who have remained at loggerheads, given Iran’s drive to ramp up production volumes to pre-sanction levels in order to regain lost market share whilst Saudi Arabia maintained that Iran put a cap on production. As a result, various meetings held by OPEC (including a non-OPEC country: Russia) within the last two years, have been majorly centred on the possibility of a cap in production volumes and these ended in stalemates until the most recently held meeting this week (on 28th September, 2016).

At its 170th (Extraordinary) meeting held in Algeria during the week, OPEC members assessed the current headwinds facing the oil sector, particularly lower oil prices and depressed oil revenues which have significantly strained fiscal position and economic growth of member countries. The Conference also considered weaker level of investments in the sector over the period which raises a potential risk of an imbalance in the future in which demand far outweighs supply. To this end, OPEC has reached out to non-OPEC oil producing countries, in a bid to restore stability to the market and mitigate any future shocks.

Consequently, the Conference elected for an OPEC-14 production target which ranges from 32.5mb/d to 33.0mb/d, a reduction of about 700mb/d in production volumes from August level. This production outline if implemented, will signal the first production cut in the last 8 years and this is expected to have a positive impact on oil prices which already increased 5.3% to US$48.7/b following the announcement. According to statements credited to the Saudi Arabian Energy Minister, Nigeria, Libya and Iran will be excluded from the proposed production cut and thus may be allowed to produce “at maximum levels that make sense”. Nevertheless, the actual production quotas for each member country is to be determined at the next OPEC meeting in November with the possibility of a proposed production cut for non-members as well.

The proposed production cut is a welcome development for the Nigerian economy, given the significant proportion of government revenue and FX earnings attributable to oil revenues which have suffered a massive dip over the last one year. It is also positive for indigenous oil producers as well the domestic banking sector which has a significant exposure to Oil & Gas assets. In the interim, all focus will be turned towards the November OPEC meeting as more clarity on the modus operandi of the proposed cut in production will be brought to light. Nonetheless, we maintain a cautious tone given that OPEC members have historically struggled to abide by production quotas, while higher oil prices will likely buoy output from non-OPEC producers and create another imbalance in the medium term.