On September 28, the Organization of Petroleum Exporting Countries (OPEC), during its meeting in Algiers, the Algerian capital, agreed to reduce oil output to a range of 32.5-33.0 million barrels per day from the current output of 33.24 million bpd. It is for the first time in eight years that the oil cartel has decided to lower output. Saudi Arabia, the largest oil producer, is expected to give up 350,000 barrels a day while other OPEC nations are also expected to lower the production. Three countries are exempted from the production cuts: Iran, Nigeria and Libya. Economic sanctions were lifted on Iran earlier this year, and Libya and Nigeria have had some of their oil facilities damaged by terrorist attacks in recent months. It is expected that the coordinated action would help to reduce supply in the market. The deal will brighten the prospects for the energy industry, from giants like Exxon Mobil Corp. to small US shale firms, and boost the economies of oil-rich countries such as Russia and Saudi Arabia. <div>
Market enthusiasm around the OPEC deal has vacillated significantly over the recent weeks, alternating between optimism and pessimism. A healthy segment of investors view the current agreement with scepticism. For instance, Adam Longson of Morgan Stanley opines, “This is not the only OPEC agreement to limit production in this downturn, and thus scepticism on finalization is warranted. For example, a production freeze agreement early in 2016 failed to materialize at the April Doha meeting when more specific commitments were required. Similarly, without country-level allocations, this latest agreement could come apart as the details are negotiated, although it appears to have more support. Even with an agreement at the November 30 meeting, actual reductions in OPEC production probably won’t be fully in place until sometime in 2017. In the interim, OPEC will look to non-OPEC for additional support, with Russia signalling willingness to freeze production at record levels, but not cut.”
And while that scepticism may turn out to be unwarranted; it is certainly possible that one or more of the OPEC members will cheat on any production agreement and overproduce, especially given the lack of effective monitoring mechanisms in place to control production. It is perhaps because of this reason that analysts at Goldman Sachs have reiterated their year-end $43 per barrel and 2017 $53 per barrel forecasts. They have cited four reasons in this regard:
- uncertainty on the proposal until it is ratified especially as it relates to Saudi cuts and Iran caps,
- likely quota beats if ratified,
- upside surprises to disrupted production as announced, and
- conservative supply forecasts outside of OPEC for next year.
It is expected that as long as Nigeria and Libya continue their comeback, the announced cuts will not result in any significant reduction of supplies.
Oil producers with deficits: High oil prices paid for social programmes from Venezuela to Saudi Arabia. Then when prices fell, those countries were stuck paying subsidies and salaries they couldn’t afford. Saudi Arabia now has the highest budget deficit among the world’s 20 biggest economies, one of the main reasons it made the U-turn.
Iran: Iran is a particular winner because it won’t even have to cut production since its exports were held back by sanctions during some of the years used to calculate its ceilings.
Non-OPEC producers: Countries such as Russia and Mexico will see oil prices rise, even though they aren’t part of the agreement to trim production. But that’s the catch: if they don’t play ball to some degree, they undermine the agreement — and their own oil revenue.
Global central banks: The Bank of Japan and the European Central Bank both want to lift inflation to meet their targets, ease debt burdens and help restore economies ravaged by financial crises. Low oil prices have stood in the way of those objectives. Even in the US, where inflation has inched up this year, the Federal Reserve has had to put planned interest rate increases on hold.
Energy companies: Stock markets rallied, with energy companies leading the way. China Oilfield Services Ltd. jumped 11 percent in Hong Kong as PetroChina Co., Asia’s biggest oil and gas producer, rallied the most since May. In Europe, BP PLC rose 4 percent, Royal Dutch Shell PLC 5.4 percent and France’s Total SA 3.9 percent.
US shale producers: All depends on whether the accord leads to a lasting increase in prices. One of Saudi Arabia’s objectives over the past years was to push the US shale industry, with its once-booming production but high costs, out of business. That’s been partly achieved, with thousands of wells now idled. “We may not get the uplift that US shale is expecting,” Harry Tchilinguirian, head of commodity-markets strategy at BNP Paribas in London, told Bloomberg Radio.
Airlines: Low oil prices have played a major role in improving the financial results of airlines. The Bloomberg World Airline Index was down 0.3 percent today, with Deutsche Lufthansa AG off 2.9 percent and Ryanair Holdings PLC falling 2.3 percent.
Car drivers: A gallon of gas averaged $2.22 a gallon at the pump in the US, down from almost $3.50 two years ago. In France, a litre of super is about 1.30 euros ($1.46), near its lowest since 2009 and down from a high of about 1.70 euros in April 2002. Some increase is now inevitable, though again that depends on how successfully the agreement holds.
The agreement to trim OPEC’s collective output by about 700,000 barrels a day, is an effort to balance supply and demand in the global oil market and it caught markets by surprise. It was well-acknowledged that the group needed to take decisive action to staunch the two-year-long slide in global crude prices, that saw Brent prices more than halve from about $103 a barrel in end-August 2014 to $45.45 a barrel on September 1 this year. Still, it was unclear if there could be a meaningful consensus on production cuts among disparate member-countries — which included the small-yet-prosperous West African country of Gabon, crisis-hit Venezuela, and fractious West Asian nations such as Iran and Saudi Arabia. That the 56-year-old grouping arrived at an agreement, albeit after leaving a decision on country-specific production targets to November, reflects just how desperate the situation had become for most oil-producing economies. The output cut, announced for the first time in eight years, is a tacit admission by the group’s largest producer Saudi Arabia that its ‘pump-at-will’ approach has hurt its economy as much, if not more, than the pain it may have caused North American oil producers, including US shale interests, that the policy largely sought to target.
While the big US shale producers have resiliently hung on and even begun investing in new acreage this year, Saudi Arabia found itself with a huge hole in its budget. A fiscal deficit of 16 percent of GDP in 2015 that is projected to slightly narrow to about 13 percent this year forced spending cuts, including on wages and fuel subsidies. This year the kingdom was driven to make its first overseas borrowing in more than a decade, a five-year $10 billion loan. With the economy’s growth set to slow to about 1 percent in 2016, it had few options but to return to the main fuel of its economic engine, crude oil. Given the country’s involvement in conflicts across the region, both openly as in Yemen and tacitly as in Syria, its rulers have possibly realised the need to squeeze more revenue out of every barrel of oil. OPEC reportedly made a concession to Iran in order to win its involvement in the deal by exempting it from immediate production caps. With demand growth for petroleum slowing far more rapidly than previously predicted, the success of the production curbs in reviving oil prices will significantly hinge on cartel discipline — something that has often been lacking in the past.