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Highlights


Higher prices may embolden countries that can to cheat on quotas

Saudi discipline, downside risks in unstable nations could cap any gains

Vast majority of OPEC spare capacity in Saudi Arabia and Gulf allies

London — If any OPEC members have been tempted to cheat on their quotas with oil prices hovering around three-year highs, they have yet to act on it.

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And despite pervasive speculation that prolonged elevated prices could encourage members to play loose with their production cut agreement, starting a slippery slope to a bruising marketshare battle with US shale producers, OPEC officials have maintained that such fears are overblown.

A closer examination of the organization's spare production capacity -- and where the downside supply risks lie -- may lend some backing to their bravado.

The US Energy Information Administration, in its Short-Term Energy Outlook released Tuesday, estimated that OPEC's "surplus crude oil production capacity" - barrels that member countries have voluntarily kept in the ground but could bring online within 30 days and sustain for at least 90 days -- stood at 2.11 million b/d as of December, all of it in the Middle East.



The International Energy Agency has a higher estimate, at 3.41 million b/d as of November. Of that, 2.23 million b/d is in Saudi Arabia, OPEC's de facto leader whose energy minister, Khalid al-Falih, has pledged to maintain output discipline while the production cut agreement remains in effect through 2018.

Much of the rest of the IEA's estimate of spare capacity rests in Saudi Arabia's close Gulf allies, including Kuwait (230,000 b/d) and the UAE (300,000 b/d).

Assuming Saudi Arabia holds to its commitment and convinces its Gulf partners to likewise rein in production, any gains by other OPEC members could be offset by declines in other countries, most notably crisis-stricken and cash-strapped Venezuela.

"On balance, when aggregated up, the compliance levels should remain very high, but they will be very uneven among member countries," said Harry Tchilinguirian, head of commodity strategy for BNP Paribas.

In fact, OPEC has overcomplied with its cuts to date, giving it some wiggle room should some countries begin to overproduce their quotas.

The latest S&P Global Platts OPEC production survey released Monday pegged compliance at 115% for the full-year 2017 among the 12 members with quotas under the deal. Those countries have cut a combined 1.352 million b/d throughout the year, surpassing their required cuts of 1.177 million b/d, S&P Global Platts OPEC survey data shows.

At the last OPEC meeting on November 30 in Vienna, when the organization extended its production-cut agreement through the end of 2018, Falih dismissed any concerns of cheating, saying that some members - which he declined to name - had indicated that their natural declines would likely accelerate in 2018 and "exceed the numbers we have signed up to."

"It is likely that cuts will be involuntarily happening at a higher level," he told reporters.

He almost certainly was referring at least in part to Venezuela, whose oil production plummeted in 2017 and shows no sign of any near-term recovery amid a severe economic crisis that has starved state oil company PDVSA of funds to repair crumbling equipment and pay worker salaries.

Venezuelan crude output fell to 1.70 million b/d in December, a 350,000 b/d year-on-year decline and its lowest level since a worker strike crippled production in late 2002 and early 2003, according to the S&P Global Platts OPEC survey.

Analysts with consultancy Rapidan Energy forecast that output could decline a further 300,000-400,000 b/d, as service companies withdraw and US sanctions hamper PDVSA's ability to restructure its debt and seek new financing.

"Corruption and lack of funds for investment and maintenance are slowly strangling Venezuela's oil sector," the analysts said in a recent note.


SUPPLY WILDCARDS


Lijla Villar, an analyst with the EIA's international energy team, said her agency also predicts a fall in production from Venezuela, along with OPEC's African members, which would temper any output increases from other members.

She added that there was "significant risk" that production could decline more than forecast in Nigeria and Libya, both of whom face constant threats of internal strife.

Libyan production averaged 980,000 b/d in December, according to the Platts OPEC survey. S&P Global Platts Analytics said Libya is unlikely to produce much more than 1 million b/d, "given technical and economic constraints, making production risks significantly greater to the downside."

Nigeria, meanwhile, has faced sporadic disruptions to its oil infrastructure that many analysts say likely will continue in 2018, particularly as a contentious general election approaches in February 2019.

"Niger Delta militias will align with rival politicians during the 2018 campaign season," Rapidan Energy said. "Attacks will focus mainly on political targets, but occasional disruptions of up to 100,000 b/d are possible."

Iran could be another downside risk, as US President Donald Trump on Friday is expected to decide whether to continue waiving sanctions on Iran's oil sector under the nuclear deal.

Analysts are divided on the prospects of Trump reimposing sanctions, which would likely take some time to implement and could be blunted by a lack of cooperation by European and Asian countries. But as much as 1 million b/d of Iranian crude exports could be impacted if the nuclear deal is scrapped.


UPSIDE RISKS


Iraq would appear to be the OPEC member with the biggest potential to raise production in the near-term, as about 300,000 b/d of output from the Kurdistan region in the north remains offline in the wake of a failed independence referendum last fall.

The federal government in Baghdad and the Kurdistan Regional Government have yet to come to any agreement on oil revenue sharing, with analysts seeing no quick resolution there. In the meantime, Baghdad has boosted its exports from its southern terminals.

The UAE, which has demonstrated a reluctance to fully implement its cuts, could also be a source of additional barrels. But with Energy Minister Suhail al-Mazrouei taking on the rotating OPEC presidency this year, analysts say the country may be prodded to make a good show of compliance.

Outside of OPEC, Russia is the key member of the production-cut alliance that bears watching. It was slow to carry out its cuts and some Russian oil companies have been less than enthusiastic participants.

Russia does not hold much spare capacity, according to analysts, but companies "will be increasingly annoyed if they have to delay project starts any further or feel obligated to keep drilling in check to comply," said Michael Cohen, head of energy commodities analysis for Barclays.


'AGILE' RESPONSE


Of course, what many market watchers are keeping a close eye on is US output, given shale's nimbleness and responsiveness to higher prices.

On that front, the EIA may have given OPEC and market bulls some pause when it forecast Tuesday that US production could rise to 10.3 million b/d in 2018, a 400,000 b/d upward revision from its previous estimate in December.

In all, the EIA projected that total world oil production would outpace demand by 230,000 b/d this year.

On the other hand, the IEA, which reports its latest forecasts on January 19, estimated in December that the 2018 call on OPEC crude would average 32.5 million b/d, meaning that if OPEC were to hold its production at current levels of about 32.4 million b/d, the market would be in deficit for the year.

A six-country OPEC/non-OPEC monitoring committee co-chaired by Falih and Russian counterpart Alexander Novak will meet January 21 in Oman to discuss the production cut agreement and assess market fundamentals.

The recent run-up in prices had Iranian oil minister Bijan Zanganeh on Monday warning that Brent crude in excess of $60/b would unleash more US shale supplies.

At the November 30 OPEC meeting, Falih insisted he was committed to seeing the deal through to the end, though he said the coalition's response would remain "agile" to market conditions.

"We will adjust, but will not be quick on the trigger," he said.

-- Herman Wang, herman.wang@spglobal.com
-- Brian Scheid, brian.scheid@spglobal.com
-- Edited by Derek Sands, newsdesk@spglobal.com