John Kemp, Reuters

Saudi Arabia’s energy minister has predicted production cuts by OPEC and non-OPEC countries will reduce global oil inventories by 300 million barrels (MMbbl) by the middle of 2017.

Six months of full compliance with the agreement would cut inventories to their five-year average and make any extension of the accord unnecessary, according to Khalid Al-Falih.

Crude exporters have been talking up compliance with the pact over the last two weeks to validate market expectations and steady prices.

But traders have become more wary as the initial surprise from the ambitious OPEC and non-OPEC deals fades and the market becomes more watchful.

The focus has shifted to questions of compliance and the resurgence of shale production in the U.S.

Softer Spreads

Spot crude prices have stalled since the middle of December and calendar spreads have been weakening after both jumped following the deals.

The calendar spread for WTI between June and December 2017 has fallen to around $1 per barrel contango from flat on Dec. 12.

Brent's time spread for second-half 2017 has also fallen to around 55-60 cents contango from flat on Dec. 13.

Nearby price discounts in Brent and WTI are still not wide enough to cover the cost of storing and financing barrels in the second six months of the year.

On balance, traders expect the market to record a supply deficit and draw down stocks of crude and refined products during the first half and into the second.

But the weaker calendar spreads imply that traders expect a somewhat higher level of inventories in the second half than before.

Prices and spreads arguably over-reacted to the surprising ambition of the OPEC and non-OPEC agreements and the market is now correcting.

Shale Redivivus

Compliance with the OPEC and non-OPEC deal appears to be fairly high though it will be some weeks before it can be assessed properly.

But OPEC and non-OPEC compliance is only one half of the story. Traders are watching the rebound in shale drilling carefully to see how many extra barrels will make their way onto the market.

Shale producers have added 108 extra rigs over the last 13 weeks, after adding 72 extra rigs over the previous three months, and 28 in the three months before that.

Even under conservative assumptions about drilling times and delays in the arrival of fracking crews, those extra rigs will all be adding to new production by the middle of 2017.

Most forecasters believe U.S. oil production will increase this year though there is considerable uncertainty about the extent.

The U.S. Energy Information Administration (EIA) forecasts onshore production from the continental U.S. will rise by around 300,000 bbl/d.

Output is set to increase from a low of 6.62 MMbbl/d in September 2016 to 6.92 MMbbl/d by December 2017, according to the EIA.

The International Energy Agency predicts U.S. light tight oil production will rise by 170,000 bbl/d in 2017.

And Saudi Arabia’s energy minister Falih put the increase in U.S. shale output at around 200,000 bbl/d this year in a recent interview.

Market Share Again

Shale production increases of 200,000 to 300,000 bbl/d would be easily absorbed by rising global oil demand and will not worry OPEC too much.

But shale output has often surprised, usually on the upside, as producers have proved more innovative, efficient and resilient than expected.

The EIA has already revised its forecast for lower-48 oil production (excluding the Gulf of Mexico) at the end of 2017 up from 6.42 MMbbl/d at the time of its October outlook to 6.92 MMbbl/d in the January edition.

If U.S. onshore output rose by 500,000 bbl/d or more in 2017, which is possible, the drawdown in stockpiles might prove more gradual.

If U.S. shale output starts rising briskly, OPEC would almost certainly be forced to respond by allowing its output curbs to expire and starting to raise production again to protect market share.

The possibility of a resumption of volume warfare is likely to weigh on both spot prices and spreads, and is probably one reason both have stalled or weakened in recent weeks.