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January is ‘the first big test’ for OPEC production deal: Analysts

Oil pump oil rig energy industrial machine for petroleum.
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Oil pump oil rig energy industrial machine for petroleum.

The OPEC and non-OPEC landmark deal to cut production by 1.8 million barrels a day in 2017 enters into force this Sunday.

The first month of implementation will be key to understand whether everyone will respect the deal, but according to analysts full compliance is very unlikely.

January will be "the first big test," Alex Dryden, global market strategist at JP Morgan, told CNBC over the phone.

Dryden doesn't expect 100 percent compliance among OPEC members, but a broad compliance of about 80 percent.

Furthermore, risks related with non-OPEC members, shale gas production, and a stronger dollar could compromise the success of the deal even further.

Participants attend the opening session of the 15th International Energy Forum in Algiers on September 27, 2016.
Ryad Kramidi | AFP | Getty Images
Participants attend the opening session of the 15th International Energy Forum in Algiers on September 27, 2016.

In late November, OPEC members pledged to cut production by 1.2 million barrels per day – for the first time in eight years. In early December, some non-OPEC countries, such as Russia, joined their efforts and promised to cut output by 600,000 barrels per day. Their aim is to lift oil prices.

"OPEC production cuts will help alleviate the current oversupply, allowing recent price gains to be sustained, and possibly providing momentum for even higher prices," Thomas Watters, global ratings credit analyst at Standard and Poor's, said last week in a note.

"But, as higher prices kick in, shale production would likely quickly ramp up, effectively capping oil prices above $60," he added.

So far, Venezuela, an OPEC-member, has already confirmed that it will cut production by 95 000 barrels a day as of January 1. Given its economic struggles, implementing the deal is in its interest.

But according to Dryden from JP Morgan, the U.S. dollar is likely to strengthen in 2017 which could force countries, like Venezuela to keep production at present levels.

"A stronger dollar puts pressure (on financial balance sheets for some countries, like Venezuela)," Dryden said.

A stronger dollar means that some countries will be more indebted and thus forced to produce more oil to offset the impact on their balance sheets.

Russia seen as a question mark

Iraq has also confirmed that it will be reducing output between 200,000 and 210,000 barrels per day.

However, Chris Weafer, senior partner at Macro-Advisory, said in a client note last week that Iraq is prepared to make excuses.

"Prior to the November 30th agreement it claimed its actual production to be much higher than the official 4.59 million barrels per day figure. It offered to give up some of the "extra" production," he said, noting that a "full or even partial compliance with that agreement is considered to be very unlikely."

Non-OPEC member Russia is also described among analysts as a "question mark."

Weafer told CNBC earlier this month that he doesn't believe Russia will obey to the commitment. He added at the time that the deal is "very weak in the detail, in particular the detail concerning the supposed contribution of non-OPEC producers."

"Even if the government was committed to contributing, it's difficult to see how they would get the companies to do it," Weafer said.

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