A worker checks the valve of an oil pipe at the Lukoil owned Imilorskoye oil field near Kogalym, Russia, in this file photo.Sergei Karpukhin/Reuters
Saudi Arabia and Russia have agreed to extend production cuts for nine months as the world's largest oil exporters seek to instill market confidence in their ability to manage supplies and underpin prices.
Ahead of an OPEC meeting in Vienna next week, the world's two largest oil exporters said they are not only prepared to renew the production agreement reached last December, but will extend it until March, 2018, to ensure inventories dissipate and demand catches up to supply.
The Organization of Petroleum Exporting Countries wants to reduce global oil inventories to their five-year average, but has struggled to do so. Stockpiles are hovering near record highs, partly because of rising production in the United States.
OPEC members have suffered tremendously from the price slump that started nearly three years ago because of oversupply. The cartel members' combined revenues for oil exports fell by 15 per cent last year compared to 2015. The OPEC countries' revenues dropped to their lowest level since 2004, even as their governments faced increasing demand for services from growing populations as well as ambitious development projects.
In December, OPEC and leading non-OPEC countries such as Russia agreed to cut production so prices could go back up. They were expected to announce at their meeting next week that they would extend that agreement by six months.
"The Saudis and Russians have come up with this news to try to surprise the market with a longer-than-expected announcement and really signal the commitment is there from the sector leaders," Richard Mallinson, an analyst at London-based Energy Aspects, said in an interview.
"I don't think they would have come out publicly unless other OPEC members and other exporting countries were brought on board, and we're starting to get those supportive statements from some of the other producers."
The big exporters had hoped their production discipline would reduce swollen inventories quickly, but were surprised by the speed with which U.S. shale producers increased drilling activity and production as prices rose above $50 a barrel.
At the same time, OPEC's own exports did not fall as quickly as production, because the Saudis and Iranians, in particular, were selling oil from their own stockpiles, Mr. Mallinson said.
The news of the Saudi-Russian agreement surged through the market on Monday, driving global oil prices sharply higher. The global benchmark Brent crude was up $1.45 at $52.29 a barrel, while the North American trendsetter, West Texas intermediate (WTI), rose $1.46 to $49.30.
Saudi Energy Minister Khalid al-Falih and his Russian counterpart, Alexander Novak, said in a statement they would "do whatever it takes" to reduce the massive inventories still on the market.
The two export powerhouses agreed the production cuts should carry through the winter months, when global crude prices typically come under pressure. "It really reflects concerns about unwinding the cuts during the winter when there's low refinery demand," said Greg Priddy, an analyst at New York-based Eurasia Group.
The major exporters are walking a fine line as they seek to reassure the market about production discipline, but not drive prices too much higher, which would allow U.S. shale producers to lock in those higher prices for a growing supply.
"They have to thread the needle between leaving too much inventory out there and pushing prices to a level that gives U.S. producers a big hedging opportunity," Mr. Priddy said. He added the ideal price for the Saudis is about $55 a barrel, at least over the short term. In the longer term, higher-cost production will be needed to offset natural oil-field declines and growing demand.
Canadian heavy-oil producers have seen some added benefit from the OPEC cuts. Big exporters such as Saudi Arabia are primarily reducing supplies of heavy and medium-grade crudes, shrinking the price differential between light oil produced from U.S. shale fields and heavy oil from Canada's oil sands.
On Monday, Western Canadian Select – the benchmark for oil sands supply – was trading for June delivery at $9.70 a barrel below WTI, according to Net Energy Inc. in Calgary. The difference topped $15 earlier this year.
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