Wall Street's best-known oil analyst says smaller nations may start 'cheating' the system if OPEC eases production cuts, and it could cause a fresh supply crunch

• Helima Croft, perhaps Wall Street's best-known oil analyst, said that the prospect of OPEC easing production cuts this week could allow smaller oil producing nations to break their commitments to cut.
• "Once OPEC starts easing cuts, can they maintain the same level of conformity or will it start to break down when we start to have more barrels coming back?" — she said in an interview with Business Insider this week.
• OPEC, Russia ,and other producers are meeting on Wednesday to decide whether to ease oil production cuts in August. They are expected to do so.
• Croft fears that if those cuts are eased, then smaller producers in the cartel will start "cheating" and producing more oil than agreed.
• This in turn would increase overall supply, unbalancing the market, and likely holding down prices.

Wall Street's best known oil analyst fears that the oil market could once again be flooded with excess oil in the coming months if OPEC+ agrees, as expected this week, to ease production cuts that have been in place for the last few months.

Speaking to Business Insider, Helima Croft, global head of commodity strategy at RBC Capital Markets, said that if production cuts are eased, that could open the floodgates for smaller OPEC members to break their commitments to cut supply. This in turn would likely imbalance the market.

In June, compliance with previously agreed cuts to oil production by OPEC+ was 108%, meaning producers in the cartel were pumping even less oil than agreed. This week, however, OPEC is set to agree to ease those cuts somewhat.

For Croft, that risks major growth in the supply of the commodity.

Croft, who is a managing director at RBC said: "I mean, countries like Russia have complied. Iraq, which has been a friendly old laggard, it's compliance has been significantly better, but OPEC is meeting now this week and it looks like going to start easing back on those cuts and putting potentially 2 million barrels on the market."

"I think a real question is, you know, once OPEC starts easing cuts, can they maintain the same level of conformity or will it start to break down when we start to have more barrels coming back?"

Smaller producers could start cheating the system

OPEC, Russia and other producers are expected to ease production cuts they decided in April when they meet on Wednesday by video conference.

The oil cartel and other countries decided to cut production by a record 9.7 million barrels in April, with cuts initially intended to take place for May and June. But a number of compliance issues prevented international oil coalition from honoring the full extent of the production cuts.

Smaller producers such as Iraq and Nigeria fell back on their commitments, with Iraq meeting only 38% of its obligations, and Nigeria complying only 19% with the promised reduction, according to a Reuters survey published in May.

The survey showed the 13-member OPEC bloc pumped 24.77 million barrels per day in May, down 5.91 million barrels from April. This meant the global oil coalition and countries in May only delivered 74% of the cuts that had been agreed.

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In early June, OPEC+ extended production cuts until July after it solved its compliance issues. The International Energy Agency said last week in its June oil market report, that compliance by OPEC and other countries stood at 108%, the best it has ever been.

Countries could start cheating again if cuts are eased

But countries could start "cheating" by not cutting production by the agreed amount if cuts are eased in Wednesday's meeting, Croft says.

"I would look to Nigeria, Angola and Kazakhstan. These are the ones to watch out for. They've made statements about getting their act together. They've made some progress, but I would still say that they are the likely backsliders," she said.

Saudi Arabia kicked off a price war with Russia on March 8 to penalise the country for refusing to cut 300,000 barrels of oil per day after prices began to tank at the start of the coronavirus pandemic

"The Russians are going to be very interesting to watch as well because it was the Russians refusal to agree that 300,000 in March had kicked off the price war," she said.

"I do think that some nervousness about those barrels coming back is putting kind of a temporary lid on prices for now and concerns about COVID-19. But I don't think the market's going to be caught off guard," Croft added.

Croft emphasised, however, that while supply could increase significantly, she does not see the market returning to a state of "unrestrained" output.

"I don't think we're going to get unrestrained output again. I just think that the potential cheating comes back always in a situation where they're easing cuts," Croft added.

The price war, along with lack storage space to store oil caused US oil prices to briefly turn negative in April for the first time in history.

Brent is trading around $42 a barrel while WTI is just shy of $40 a barrel. At the start of the year before the pandemic kicked off, Brent was trading just below $65 a barrel.

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While both West Texas Intermediate and Brent staged a remarkable come back in May and June, Croft still thinks both benchmarks have a long way to go before they can hit their pre-pandemic levels.

She said: "The path to $60 a barrel is, stronger signs of demand and really clear indicators that COVID-19 is not going to have that kind of detrimental impact on demand that we might have if there is a second wave of coronavirus."

Croft cautioned: "It might be too soon to declare victory in terms of the demand picture."