OPEC's unexpected agreement to trim production shows the cartel still has the resolve - and even desperation - to try to guide energy markets higher. But don't expect triple-digit oil prices anytime soon.
OPEC’s unexpected agreement to trim production shows the cartel still has the resolve – and even desperation – to try to guide energy markets higher. But don’t expect triple-digit oil prices anytime soon.
Ministers from the oil cartel reached a preliminary deal Wednesday in Algeria to cut production for the first time since the global financial crisis eight years ago. The size of the cut was modest – to between 32.5 million and 33 million barrels per day from just below current levels of around 33.2 million barrels per day.
Though limited, the decision came as something of a surprise – expectations were that once again the regional rivalry between Saudi Arabia and Iran would create a stalemate. Oil prices shot up by around 5 percent in the wake of the cut.
On Thursday, markets stabilized, with the benchmark New York rate 23 cents lower at $46.82 a barrel and the international standard, Brent, 34 cents lower at $48.87.
Any failure to enact the agreement could lead to a renewed drop. And that risk remains – the deal, after all, is not done yet.
Output levels for individual countries will have to be finalized at a meeting of the Organization of the Petroleum Exporting Countries in Vienna in November. OPEC agreed that Nigeria, Iran, and Libya would be exempted from making big cuts as their economies are already stymied by conflicts or sanctions.
The main concern ahead of the meeting centered on Iran, which has been resistant to cutting production, as it’s trying to restore its oil industry since emerging from international sanctions over its nuclear program earlier this year.
”We see this more as an act of desperation,” Commerzbank analyst Barbara Lambrecht said. ”Saudi Arabia appears willing to bear the main brunt of the burden.”
Saudi Arabia, the world’s biggest producer, played a key role in the OPEC policies that helped push oil prices sharply lower over the past couple of years.
In the summer of 2014, oil prices were trading above $100 a barrel but increased output from non-OPEC countries, particularly the U.S., created an oversupply in the market. Instead of cutting production, OPEC opted to pump at high volumes to maintain market share and, seemingly, to drive U.S. shale oil and gas producers, who have higher operating costs, out of business.
Crude prices plunged, and in January of this year fell below $30 for the first time in more than a decade. The lower prices have hit many oil-producing countries hard, particularly poorer OPEC members Venezuela and Nigeria, but also non-OPEC states Russia and Brazil. It’s also taken a toll on Saudi Arabia – its public finances are not as strong as they were and the country’s credit rating has been downgraded.
Oversupply isn’t the only reason oil prices have remained under pressure. Weaker economic growth in energy-hungry China, for example, has had a big impact. Earlier this month, the International Energy Agency said growth in oil demand had slowed significantly during the third quarter.
OPEC’s hope now is that it will be able to get non-OPEC members, such as Russia, to get aboard its strategy to trim output.
”Good luck with that one!” quipped Michael Hewson, chief market analyst at CMC Markets. Moscow is still smarting from economic sanctions and the period of low prices, which have caused a painful recession and blown a hole in its state budget.
One potential impact of the understanding forged in Algiers is that any material increase in oil prices could encourage U.S. shale oil and gas producers back into the market, thereby offsetting any impact in prices – in the longer-term as it takes time to kick start production given financial constraints.
As a result, analysts don’t expect three-digit oil prices anytime soon.
Once the OPEC deal is confirmed, Marino Valensise, Head of Multi Asset at Barings Asset Management, said oil prices will likely drift higher to between $55 and $60.
”At those levels, shale producers in the States will inevitably increase production and there will be no potential through that price level,” he said.
Whether or not the OPEC deal sticks and whether ”cheating” can be controlled, analysts said this didn’t herald a return to the era when OPEC could basically control the oil market through its production levels, not least because non-OPEC countries have a bigger stake than before. Four of the world’s top 5 producers aren’t even part of OPEC.
”It is just as impossible to restore the conditions that used to prevail on the oil market as it is to step twice into the same river,” Commerzbank’s Lambrecht said.