Non-OPEC cuts will rely on natural decline curves

Oil prices continued to rise Monday on news that non-OPEC producers had come together over the weekend and agreed to cut 558 MBOPD, equal to the anticipated demand growth next year in China and India, according to data from the IEA. Taken together with OPEC’s 1,200 MBOPD cut, announced November 30, the production cuts promised by OPEC and non-OPEC producers now account for roughly 2% of global supply.

Who’s cutting?

Which non-OPECs agreed to cuts over the weekend?

Russia – 300 MBOD

Mexico – 100

Azerbaijan – 35

Oman – 40

Kazakhstan – 20

The majority of the non-OPEC cuts will come from Russia, which agreed to scale back its output by 300 MBOPD next year, down from a 30-year high last month of 11.2 MMBOPD. Joining Russia in the non-OPEC cuts are Mexico, Azerbaijan, Oman and Kazakhstan, which have agreed to cut 100 MBOPD, 35 MBOPD, 40 MBOPD and 20 MBOPD, respectively.

“This is truly a historic event,” said Russian Energy Minister Alexander Novak. “It’s the first time so many oil countries from different parts of the world gathered in one room to accomplish what we have done,” he added, speaking alongside Saudi Oil Minister Khalid al-Falih.

Mexico’s contributions would be made through “managed natural decline,” delegates said, indicating that the country will allow the natural decline curve to cut production, rather than consciously shutting in fields. Many of the other non-OPEC producers taking part in this deal, including Russia, are expected to use a similar tactic in order to comply with the agreement. Older, less economic production will likely be the target of these policies, allowing the countries to continue developing new projects.

Neither OPEC or non-OPEC producers provided a detailed list of production cuts following the announcement.

Saudi Arabia says it’s ready for even more cuts

The deal today appears to have given Saudi Arabia more confidence in the overall production cut regime as well, with Falih saying the kingdom is now ready to commit to even deeper cuts, if necessary. “We have full faith compliance will be high,” the oil minister said.

“Emotionally, the market will likely rally,” Adam Ritchie, founder of AR Oil Consulting, said to Bloomberg. “But beyond rebalancing supply and demand, we have excess inventory that is astronomic that will continue to keep a lid on prices.”

Now that a deal has been struck, and appears to have the backing of all the disparate parties, the next question markets will be waiting to answer is whether or not OPEC and non-OPEC producers will comply. History tells a less than comforting story, with OPEC members often cheating on quotas, and Russia increasing output in 2001 after agreeing to a similar deal.

“The oil-price crash impelled terrified producers into collective supply restraint agreements,” said Bob McNally, founder of consultant Rapidan Group in Washington and a former White House oil official. “Occasionally these loose, ad-hoc producer agreements enjoyed temporary success, but all eventually failed due to cheating.”

More than half the world’s oil production represented in OPEC and non-OPEC agreement

Despite concerns surrounding potential implementation, the addition of non-OPEC producers to the OPEC production cut agreement represents a historic event. It is the first time OPEC has convinced non-OPEC producers to join in output cuts since 2001, when the Sept. 11 attacks on the U.S. homeland sparked a recession and a fall in oil demand. Saturday’s agreement cuts deeper and involves more countries than the 2001 deal.

It also is the first time since the 1970s that a coalition of countries whose oil production amounts to more than half of global supply has come together to influence crude prices. OPEC’s own market share hasn’t been that large since the 1970s, and previous deals with non-OPEC producers have been less comprehensive.

Oil prices traded lower throughout the course of Monday after spiking on news of non-OPEC cuts, but still closed higher than on Friday. U.S. crude oil benchmark WTI closed up 1.8% for the day at $52.44 per barrel while international crude oil benchmark Brent ended the day 1.9% higher at $55.36 per barrel.