Global oil markets have gone from strength to strength following an unprecedented level of cooperation between OPEC and non-OPEC oil producers to reduce global oil supplies in an effort to shore up prices and resuscitate their ailing economies. The alliance of oil-producing countries, which accounts for around 60 percent of global oil supplies, has pledged to reduce output by almost 1.8 million barrels per day (mb/d) starting January 1, 2017. Non-OPEC producers reached an agreement on December 10 to reduce supplies by around 560,000 b/d (kb/d), which followed OPEC’s November 30 production accord to cut output by 1.2 mb/d.

A month of shuttle diplomacy led by Saudi Arabia and Russia delivered the first joint pact by the two producer groups in 15 years and, on paper, includes participation by 24 countries. The agreements are not without some serious flaws. The non-OPEC agreement is largely window dressing and cobbled together to meet OPEC’s insistence that its commitment to reducing its own production was conditional upon the participation of major non-OPEC producing countries. Of the non-OPEC producers, only Russia is expected to marginally reduce production, with “pledged cuts” from most other countries largely reflecting lower output – due to normal decline rates at mature fields – that has already been factored into the global supply outlook for 2017.

In addition, a history of poor compliance suggests actual production volumes cut will be around 60 percent of the stated 1.8 mb/d target. Nonetheless, production cuts in a lower 1-1.2 mb/d range are deemed constructive for stronger oil prices and expected to accelerate a rebalancing of record high global stocks that have weighed on oil markets for more than two years.

Following the new production agreements, forecasts among oil analysts at investment banks are now coalescing  around a higher range of $52-60 per barrel (bbl) in 2017, supported by the gradual rebalancing of oversupplied markets in response to supply cuts by the group and demand growth of 1.2-1.3 mb/d. Exceptionally, several banks are predicting a stronger $70/bbl in 2017. Oil analysts, however, argue prices will be capped at the upper limit of $60/bbl since the loftier levels would be expected to ignite resurgence in fast-cycle U.S. shale oil production, adding downward pressure on prices. For revenue-starved oil producers, the current price forecast represents a significant increase above the $44-45/bbl average levels seen for much of 2016 and will provide billions of dollars in additional government oil revenue in 2017.

Oil futures prices for benchmark crudes breached the $50/bbl threshold on December 1 following OPEC’s deal to rein in production. Prices rose to the highest levels in 17 months after non-OPEC producers finalized their agreement 10 days later. U.S. West Texas Intermediate futures have traded in a much stronger range of $51-53/bbl and international Brent crude has traded in a higher band of $54-55.75/bbl in recent weeks. However, following the initial post-agreement jump in prices, further increases are expected to be tempered in the new year since lower production levels will only become apparent after several months.

OPEC’s Gulf Arab Members to Shoulder Burden of Production Cuts

OPEC and non-OPEC officials lauded the historic pact, but market analysts remain concerned about the numerous and significant weaknesses in the agreements. OPEC’s hard-won production cuts were achieved through a combination of high-level political consultations by Saudi Arabia, Russia, and Iran; an unprecedented level of compromise; and very creative arithmetic to reach the targeted cut. In the end, only 10 of the organization’s 14 members pledged to reduce production. Unwilling to accept a cut in production, Indonesia suspended its membership. Iran’s new quota was actually increased above its maximum production capacity level via complex and fuzzy calculations. Meanwhile, strife-torn Libya and Nigeria were exempt from the cuts, which is another weak link in the deal. Current production levels were used in assigning new production allocations but, in all probability, resumption of some disrupted supplies from Libya and Nigeria will add anywhere from 200-500 kb/d in the first half of 2017, partially offsetting agreed cuts by other members.

While the machinations to reach the 1.2 mb/d cut were unorthodox, the strength of the OPEC accord lies in the commitment to reduce supplies by Gulf members Saudi Arabia, Kuwait, the United Arab Emirates, and Qatar, as well as Algeria, who all have a history of strong compliance. The five countries are expected to account for just under 900 kb/d, or over 75 percent of the pledged cuts. Contributions from the other five members are less clear but may add a further 100 kb/d.

In an effort to quiet analysts’ concerns and add more weight to the agreement, Saudi Arabia’s Energy Minister Khalid al-Falih said the kingdom was prepared to make deeper cuts if needed. “I can tell you with absolute certainty that effective Jan. 1 we’re going to cut and cut substantially, to be below the level that we have committed to on Nov. 30,” he said.

By contrast, the non-OPEC agreement is far weaker and less substantial. While hailed as the first joint agreement in 15 years, in reality non-OPEC producers never implemented cuts agreed to with OPEC in the past. However, OPEC’s insistence that major non-OPEC producers participate in this round led to an imprecise agreement that set no individual production cuts but rather allows for countries to claim natural declines in production levels as their contributed cuts. Following the meeting of OPEC and non-OPEC officials in Vienna on December 10, a press release was issued that stated non-OPEC producers “proposed to adjust their production, voluntarily or through managed decline.”

Of the 11 countries in the pact, only Russia is expected to reduce supplies and, even then, volumes will likely be less than the pledged 300 kb/d. Russian Energy Minister Alexander Novak said the reduction will be gradual with production forecast for the end of March 2017 to be reduced by 200 kb/d, from the October 2016 record level of 11.2 mb/d, and by another 100 kb/d to 10.9 mb/d after six months. Pledged cuts from seven countries merely reflect expected lower production due to normal decline rates at mature fields and were already factored into the global supply outlook for 2017. Mexico, Malaysia, Azerbaijan, Equatorial Guinea, Bahrain, Brunei, and Oman all have mature fields that were forecast to decline naturally, in part due to two years of lower capital expenditures. Production from Sudan and South Sudan has been declining due to unplanned disruptions. Meanwhile, Kazakhstan pledged to reduce production by 20 kb/d only a month after its decade-long delayed, massively expensive $55 billion Kashagan project came online. As a result, most analysts don’t expect the country to comply with its pledge and are forecasting an increase in the country’s production.

Oil Markets Rebalancing Delayed by a Surge in OPEC Production

With the planned production cuts not expected to materially impact the market until the end of January at the earliest, oil traders and analysts have shifted their focus to supply and demand fundamentals for near-term price signals. The International Energy Agency’s latest Oil Market Report projects global oil stocks will build sharply in the fourth quarter of 2016 on surging OPEC production, making implementation of the new production pact more challenging. Ahead of OPEC’s November agreement, members ramped up output by 300 kb/d to record levels of 34.2 mb/d, with a more substantial cut of 1.7 mb/d now required to reach the new January target of 32.5 mb/d, according to the report. OPEC’s record output is behind the updated forecast for a steep rise in Organisation for Economic Co-operation and Development members’ commercial inventories of 1.1 mb/d in the fourth quarter compared with much smaller increases of 200 kb/d in the previous two quarters.

However, adjusting OPEC production lower at the start of 2017 to around 32.9 mb/d, or 500 kb/d above the official target, assuming less than perfect compliance, would lead to a supply deficit during the first half of 2017, with demand potentially outstripping production by an average 450 kb/d. Assuming the lower productions levels are maintained throughout the year, global oil stocks are estimated to decline by just under 900 kb/d in the second half of 2017.

The pace of the market rebalancing will also be hastened by upward revisions to oil demand growth projections. The International Energy Agency revised is forecasts for oil demand growth by just over 100 kb/d for both 2016 and 2017. Demand is now expected to increase by 1.4 mb/d, to 96.3 mb/d, in 2016 and by a further 1.3 mb/d, to 97.6 mb/d, in 2017.

Counting Barrels

The current supply and demand balance is supportive for higher prices in 2017 but the first quarter remains vulnerable to downward pressures, with monitoring of OPEC and non-OPEC compliance difficult to verify in the first few months of the year. Saudi Arabia, Abu Dhabi, Kuwait, Qatar, Algeria, Angola, and non-OPEC Oman have notified customers of production cuts effective January 1, 2017. If fully implemented, these cuts would total around 960 kb/d, which represents about 55 percent of the promised 1.8 mb/d in cuts.

At the same time, cracks in the agreements are already starting to emerge. Libya, which is formally exempt from the agreement, is preparing to restart production at two key oil fields and a pipeline in western Libya that have been shut down for over two years. One official said roughly 200 kb/d of additional crude could come online within a few days. OPEC has not set up a mechanism to allow for higher production from Libya or Nigeria but it was inferred that other members would have to reduce production further to offset any increases by the two countries.

More troublesome, reports have emerged that Iraq may already be flouting the terms of the agreement, with plans to raise crude oil exports in January rather than reduce supplies by its pledged 210 kb/d. Iraqi government data show exports are slated to rise by almost 400 kb/d in January over December levels. Iraq was one of the last holdouts to sign on to the November agreement, which early on raised alarms about its commitment to the accord. Iraqi Oil Minister Jabar Ali al-Luaibi argued strongly throughout the negotiations in Vienna that the country should be exempt from the agreement because of its costly war against the Islamic State in Iraq and the Levant. At the eleventh hour Iraqi Prime Minister Haider al-Abadi told Luaibi to get the deal done.

Given OPEC’s poor history of compliance, for the first time in its history the group established a committee to monitor implementation of new production targets. The joint ministerial committee is comprised of OPEC members Algeria, Kuwait, and Venezuela, and non-OPEC Russia and Oman. The inclusion of Venezuela is a bit like having the fox guard the hen house given its well-documented history of ignoring its own quotas. OPEC Secretary General Mohammad Sanusi Barkindo said, “The establishment of the joint Ministerial Committee to oversee compliance, makes the Vienna Agreement measurable and verifiable” but offered few details on how the group would go about its task. Many members do not provide reliable production data to the OPEC Secretariat so analysts gather information from tanker movements, consultants, or confidential industry sources to access output levels. Given the sensitivity, even OPEC Secretariat officials use an average of secondary sources for the Monthly Oil Market Report rather than challenge their members about the accuracy of the data submitted. The new monitoring committee is reportedly looking to hire tanker tracking companies to assist in monitoring export levels. The committee’s first meeting is planned for late January or early February.

Given the dearth of official data on production levels, in the near term market analysts will parse through media reports for evidence of lower or higher customer allocations, dissecting statements by OPEC ministers about compliance levels and tracking tanker movements on computer screens. In other words, markets will be held hostage to rumors and innuendo until more solid information on production levels emerges after several months. As a result, oil prices will ebb and flow with headlines but are nonetheless expected to hold in a $50-60 range in the early months of 2017.

Diane Munro is a former senior oil market analyst at the International Energy Agency and a contributing writer at the Arab Gulf States Institute in Washington.