Fitch: OPEC Move Limits Oversupply Risk, but Shale Key Long Term

The decision of OPEC, Russia and other oil-producing countries to extend their deal on production cuts reduces the potential for a significant market oversupply in 2018, Fitch Ratings says. We believe the extension has already been largely factored into oil prices, which are more likely to stabilise at USD50-60/bbl in the coming years; however, much will depend on the performance of US shale.

Under the agreement announced on Thursday, OPEC, Russia and the other signatories will maintain their 1.8 million barrels a day of production cuts until end-2018, subject to an interim review in June 2018. We believe this should result in a broadly balanced market or only a marginal surplus in 2018, assuming an increase of around 1 million barrels per day (mmbpd) in average US shale oil production compared to 2017, and that compliance with the cuts remains solid.

Many factors could affect this expectation, including production volumes in politically unstable regions, the scale of the US supply response to recent price increases, deteriorating compliance with the cuts, or the risk of disruptions to Venezuelan oil exports in the context of a PDVSA or sovereign debt restructuring. These factors could bring the market into deficit or further into surplus. This high level of uncertainty supports our continued cautious stance on oil prices for 2018 and beyond, compared to current market prices. Our price assumptions include an average Brent price of USD52.50 a barrel in 2018, rising gradually to USD57.50 a barrel thereafter.

Saudi Arabia and Russia are the driving forces behind the deal on production cuts and their commitment to the deal has remained strong. Saudi Arabia cut production by more than required, offsetting insufficient compliance from Iraq, Iran and UAE. Russia also helped to bring other non-OPEC producers into the deal and fully met its obligations.

We believe both countries have a strong interest in stable oil prices into 2018, as Russian presidential elections are scheduled for March and Saudi Arabia is preparing Aramco's initial public offering. However, Russia's commitment to the deal may become less pronounced, as companies with production growth potential, such as Rosneft and Gazprom Neft, may challenge it. In addition, Russia needs a lower oil price than Saudi Arabia to balance its budget.

OPEC and other pact participants have agreed to review the deal in June 2018. This in theory allows them to more quickly react to the market conditions but it also increases the chance that the agreement could be discontinued while the market is still in surplus if participants have a different view on rebalancing and fail to reach a consensus during the next meeting.

Oil inventories remain well above the five-year average despite the production cuts and progress in reducing them has been slower than expected due to rising output from Nigeria and Libya, which were originally excluded from the pact. The countries' agreement to limit cumulative production to 2.8mmbpd, close to the current level, should not have a significant impact on the supply-demand balance in 2018, as their near-term production upside is limited.

US shale production can also respond rapidly to changing market conditions and the recent price recovery increases the probability of strong shale production growth in 2018. US shale is likely to satisfy most of the incremental oil demand in 2018 and we believe it has the capacity to remain the key incremental supplier for the next several years.

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