Music to OPEC’s ears: IEA sees cartel’s oil strategy as having ‘intended effect’

The past year has, without a doubt, been a momentous one for oil markets. Prices began their precipitous plunge in mid-2014, only for OPEC’s shift in strategy in November last year to send them even lower.

At the time, OPEC argued that the market should be left to balance itself, and that it should be the higher-cost oil that should be removed from the market first — not the lower-cost OPEC oil.

But many questioned the strategy as US shale oil output continued to surge despite lower prices as producers found ways to improve efficiencies and keep on drilling. But all the while OPEC stuck with its strategy, pumping out crude at levels not seen since 2012 when oil was trading at over $100/b.

Prices in the past month fell to six-and-a-half year lows on this continued oversupply, causing pain across OPEC and non-OPEC producers alike as revenues from oil exports more than halved.

But the latest forecasts from the International Energy Agency, published Friday, suggest that maybe OPEC was right to stand its ground.

The IEA said that non-OPEC oil supply was set to plunge in 2016 by almost 500,000 b/d as the renewed fall in oil prices took its toll on producers in the US in particular, but also in Russia and the North Sea.

Coupled with an increase in the agency’s forecast for global demand, the “call” on OPEC crude next year will rise by 500,000 b/d to an average of 31.3 million b/d.

But that only tells half the story. For the third quarter of 2016, the IEA sees demand for OPEC crude at 31.8 million b/d and for the fourth quarter at a staggering 32 million b/d.

The IEA said that this appeared to be evidence that OPEC’s market share strategy was bearing fruit.

“On the face of it, the Saudi-led OPEC strategy to defend market share regardless of price appears to be having the intended effect of driving out costly, ‘inefficient’ production,” it said.

This will be music to OPEC’s ears. There have been many that have doubted the OPEC strategy, and there are many that will continue to do so. Some observers even doubt the relevance of OPEC as an organization, given its reluctance to intervene and balance the market by reducing production.

But as the IEA notes, OPEC will be expected to produce up to 32 million b/d in the second half of 2016 to keep markets in balance given the expected fall in non-OPEC supply.

That is considerably more than it is currently producing — the IEA pegged OPEC output in August at 31.57 million b/d.

So, clearly, the role of OPEC in providing the world with sufficient crude in the future remains undiminished if the IEA data is anything to go by.

Assuming no unexpected supply outages, the return of Iranian oil to global markets would more than make up the shortfall.

Once international sanctions against Tehran are lifted — expected by the end of this year or the start of 2016 — Iran has said it would be able to double exports from the current 1 million b/d within six months.

And then there’s Libya. Able to produce 1.5 million b/d at capacity, it has been averaging less than 400,000 b/d for most of this year. So any recovery in production from the North African country could see another one million b/d hit global markets.

For now, though, even with prices still under $50/b, OPEC can at least look at the IEA report with some satisfaction.