On Wednesday U.S. crude settled up 9.3% at $49.44 per barrel after OPEC finalized a deal to cut output for the first time since the global financial crisis in 2008. OPEC agreed to cut approximately 4.5%, or 1.2 million barrels per day (mb/d), from their collective output starting in January 2017. After the cuts are implemented, OPEC is targeting production of 32.5 mb/d from 33.7 mb/d now. Each OPEC member is responsible for enforcing what the cartel is calling “an allocation of oil production adjustments,” instead of production quotas. OPEC is known for cheating, however, so an internal committee will oversee enforcement as a precaution.
Indonesia Takes a Breather
For some member states, like Indonesia, the proposed cuts were simply too much to ask. Indonesia used to be an oil exporting country, but became a net importer several years ago. The country was re-admitted to the cartel last summer, but does not really seem to have a role to play any longer. So when the rest of the cartel announced an output reduction agreement, Indonesia took the opportunity to suspend its membership. The Indonesian government tried to put on a brave face and said the membership was being suspended rather than revoked. Time will show. (For more see: Does Indonesia’s OPEC Membership Matter?)
OPEC Deal Was Hard Won
Not many oil market observers expected OPEC to reach an agreement at this meeting, but the cartel’s credibility and even relevance was on the line. Saudi Arabia, perhaps because of its quasi-leadership role in the group, was particularly keen on reaching an agreement. When the meeting started, Saudi said any agreed cuts would be allocated among member states based on their respective percentage of output. If this were true, then the percentage of cuts should look something like the chart below, which is based on OPEC’s production figures in October 2016.
Instead, the actual cuts agreed at Wednesday’s meeting are more like this, based on figures discussed during OPEC’s press conference.
Saudi Arabia agreed to a larger proportion of oil production cuts than it should have if the percentage was actually based on output. When the story first broke, Reuters reported that, “Saudi is prepared to take a ‘big hit’ to its own production to reach an agreement.” Several countries like Iran, Nigeria and Venezuela are not really participating in the agreement. For example, Iran agreed to freeze production at 3.797 mb/d, which is actually a 90,000 b/d increase from October output levels. Nigeria negotiated an outright exemption from cuts. Most likely this is because of the country’s fragile macroeconomic and financial condition. (For more see: Nigeria Badly Needs OPEC Agreement).
Russia Is Also Part of the Deal
Key to making this agreement more credible was the announced participation of non-OPEC countries. At the press conference, OPEC said it expected non-OPEC countries to cut production by 600,000 b/d in 2017, with fully half of that amount coming from Russia alone. Russia’s Energy Minister Novak had earlier said that Russia would suspend 2017 production increases in support of OPEC, but instead Russia agreed to actually reduce current production levels. Lukoil (MCX:LKOH) said it would abide by the Russian governments agreed cuts, but the Russian government is more likely to lean on state owned producers to deliver production cuts rather than private companies.
The Bottom Line
OPEC has done a good job of making its presence felt on the global oil markets again. Not only were they able to negotiate an agreement among member countries, but even convinced some non-OPEC members to join in to the agreed production decline. Many analysts now expect oil prices to rise from here. The next stop along the way will be the $60 per barrel mark, which is the price at which U.S. shale oil should start coming back on line in a meaningful way. It will be interesting to see what OPEC’s next move will be when they meet again in six months.
Disclaimer: Gary Ashton is an oil and gas financial consultant who writes for Investopedia. The observations he makes are his own and are not intended as investment advice.