OPEC compliance in focus as oil group announces output cut

The Organization of the Petroleum Exporting Countries (OPEC) on Wednesday agreed to its first oil production limits in eight years, triggering an oil rally, but market watchers were questioning whether the oil group will cheat.

"The key to all of this is really is whether these cuts will be implemented. That is the big question,"said Matt Smith, ClipperData's director of commodity research from Kentucky.

On Wednesday,all 14 member countries reached a deal to curtail oil production for the first time since 2008, the oil-producing cartel announced from its headquarters in Vienna.

OPEC ministers confirmed it had secured a cut in its oil production from 33.8 million barrels a day to 32.5 million barrels a day in an effort to prop up prices. Oil prices have fallen by more than half since mid-2014 due to global oversupply and booming U.S. shale production.

OPEC's announcement sent crude oil prices soaring over 10 percent on Wednesday to over month highs over $50 a barrel. Crude oil prices gave up some of the gains on Thursday morning in Asia with U.S. West Texas Intermediate down 0.6 percent at $49.16 a barrel and European Brent down at 0.4 percent lower at $51.65 a barrel at 9.35am HKT/SIN time.

The logo of OPEC is pictured at the OPEC headquarters on the eve of the 171th meeting of the Organization of the Petroleum Exporting Countries in Vienna, on November 29, 2016.
Joe Klamar | AFP | Getty Images
The logo of OPEC is pictured at the OPEC headquarters on the eve of the 171th meeting of the Organization of the Petroleum Exporting Countries in Vienna, on November 29, 2016.

Kuwait, Venezuela and Algeria all agreed to monitor compliance of the OPEC agreement, according to a Reuters report. But there are no penalties for non-compliance and members have a poor track record of adhering to previous production quotas.

Smith wasn't alone in skepticism over whether the deal was more than a piece of paper.

"Experience teaches us that many people will be skeptical about compliance and with probably good reason to be so," said Head of APAC Research at Wood Mackenzie, Craig McMahon in Singapore.

Under the deal, OPEC's de facto leader, Saudi Arabia, will take the lion's share of cuts by reducing output by almost 500,000 barrels a day to 10.06 million barrels a day. Its Gulf OPEC allies - the United Arab Emirates, Kuwait and Qatar - would cut by a total 300,000 barrels a day.

Iraq, which had insisted on higher output quotas to fund its fight against Islamic State militants, unexpectedly agreed to reduce production by 200,000 barrels a day.

Some producers like Saudi Arabia committed to supporting prices will likely abide by the new rules, but other countries may be less motivated, Smith told CNBC's "The Rundown" on Thursday.

Even if OPEC stands by its cuts, oil producers outside the organization may not turn off their taps. Higher crude oil prices will also feed a vicious cycle of higher prices feeding higher production, particularly from low-cost U.S. shale oil producers.

The sharp oil-price rally may well be short-lived, as oil production was turning the corner in the U.S., with the rig count up 50 percent from lows in May, Smith said.

But Wood Mackenzie's McMahon said crude oil prices will need to stay sustainably above $55 a barrel to trigger a significant increase in U.S. shale production.

Market watchers were now keeping their eyes on a non-OPEC meeting next week to see if Russia will also play ball.

OPEC has said it is seeking to secure 600,000 barrels per day of cuts from non-OPEC producers, and that Russia has committed to temporarily cut production by about 300,000 barrels per day.

Reuters contributed to this article.

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