OPEC Cuts Output

Yesterday, OPEC made the historic decision to cut their production by 1.2m barrels a day. This was a move that should not have been a surprise, as when they met in Algiers two months ago they said a deal would be made. Yet, as was clear from the price of Oil in the last two months, the markets did not fully believe them. The initially rumours of a deal in Algiers sent Oil $6 higher to $54, however, Brent gave back all of that and touched below $45 in mid November. Positive rhetoric from pre-meeting talks saw Oil recover and finally yesterday as it became clear a deal would be done Oil prices soared around $4 on the day and touched a high of $52.71 early this morning.

In the build up to the meeting, it was disagreements between Saudi Arabia, Iraq and Iran that were looking to prevent a deal. Iran has been rapidly increasing its Oil supply after sanctions were lifted and wanted to be exempt from any cuts. Iraq were also playing hardball with agreeing to any cuts. In the end, Iran have agreed to a production cap of 3.8m barrels, a level just above their current output, so that represents an increase in production. Libya and Nigeria were granted exemptions from cuts, as was known prior to the meeting. Everyone else agreed to cut, including Iraq, by nearly 5%. This will take production to roughly 32.5m barrels from OPEC, which is responsible for roughly a third of the world’s supply.

The other significant deal reached was cuts from non-OPEC countries. OPEC are looking for 600K worth of cuts from other countries. Russia have already stated they will cut by 300K, but they say this will be a gradual cut for technical reasons. There was a suggestion that the OPEC deal was contingent on other nations agreeing to cut as well, but this does not appear to be the case and they are hoping other nations will follow their lead.

The deal itself will come into effect in January and will last for 6 months, with the possibility of extending it until the end of 2017. This means, that they have one month to boost production and earn a little extra revenue ahead of production cuts. In November OPEC production topped 34m barrels, a new record, as the members boosted production in anticipation of a cut, as well as trying to strengthen their position so they would end up cutting less.

One of the largest market moves on the day came from the announcement that Indonesia have suspended their membership of OPEC. It was initially unclear whether they had been kicked out, or left willingly, however, that was not what drove the market. It was also rumoured, that Indonesia’s share of production would be spread out to the remaining members. Indonesia’s production stands at 800K barrels, meaning the touted 1.2m cut, would have only been a 0.4m cut. This sent Oil back down by a dollar quickly, although it recovered just as quick when OPEC made it clear that the 800k would not be redistributed.

There are still a lot of things that remain to be seen. Most importantly, whether the nations will actually observe the cuts and limit their production, or will they try to sneak out extra. America’s response to this could also drive prices. For the last two years Saudi Arabia’s policy had been to increase production despite a falling price, in the hopes of drive out US Shale Oil and other high cost producers. It had become clear to them, that that strategy was not working and a change of tactic was needed. If Oil price remains significantly higher for longer because of the cuts, expect to see US production pick up again, a first indication of which could be seen in the weekly rig count data.

Despite what many doubters thought, OPEC managed to negotiate what appears to be a strong deal to limit output. It came at a time and probably because of financial pressures that many member Government’s were facing. The Arab peninsula has been a hub of economic growth and development, but this was paid for by Oil and the recent low prices were taking their toll on these countries. It also gives OPEC back a lot of its power, as many were questioning whether they could impact the marker any more, after years of inaction and in-fighting. Their actions have already seen Oil 10% higher, and many are now calling for prices to stabilise in 2017 around $60 a barrel.

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Reuters: Business News