September 29, 2016    4 minute read

OPEC’s Oil Production Cap: Why It Was Needed And What’s Next

A Close Look At The Markets    September 29, 2016    4 minute read

OPEC’s Oil Production Cap: Why It Was Needed And What’s Next

The Organisation of Petroleum Exporting Countries (OPEC) has reached a decision, ending its 2014 pump-at-will policy in a historic meeting in Algiers, Algeria. In a preliminary deal announced late on Wednesday evening, OPEC agreed for the first time in eight years to cut the group’s combined production.

The First Effects

News of the agreement sent Brent crude rocketing up to $48.69 as Saudi Arabia looked past differences with rival Iran in an effort to stabilise the oil market. After a two-year hiatus from supply intervention, which has bore witness to global oil prices slump as much as 75%, OPEC’s largest producer signalled they wish to be back in the driving seat.

According to Will Kennedy, from Bloomberg, “two years ago Saudi Arabia instigated a policy that said we had to grab market share, we have to defeat shale, we should produce as much as we can, that ended today.”

The deal could result in a cut in production to as low as 32.5 million barrels a day for the cartel, although specific production targets are likely to be agreed in November. A reduction in output that far would result in stripping approximately 750,000 barrels from OPEC’s current levels.

Unexpected Agreements

Saudi Arabia has defied analyst expectations and agreed for Iran to be exempt from this accord, only five months after talks to cap production in Doha fell through when the latter would not participate. Friction grew between the two nations as Iran returned to the market following the lifting of sanctions by the UN. While both continue to back opposite sides in Yemeni and Syrian civil wars, it is a strong and unexpected step in the right direction.

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Commentators suggested deteriorating conditions in the Saudi nation may have been a stronger driving force than ambivalent intentions, and that OPEC’s general had been forced to change tack. Saudi Arabia is forecasting a fiscal deficit for 2016 of 13.5% of GDP and made headlines this week after a royal decree cancelled state employee bonuses among other budget cuts. After postponing a government bond issue, many speculated Saudi Arabia would be forced to intervene to avoid a repeat of last winter’s $30 crude oil handle.

“Spending on wages soared as oil prices boomed, that era is over; wage spending has to be cut.”

Simon Williams, HSBC

Russia is also not bound by the agreement, participating in talks in Algiers but not included in the group reducing output. Energy Minister Alexander Novak indicated an output freeze would be preferable for the country if any restriction on production was going to be necessary,

However, even that seemed unlikely as early estimates indicated Russia had shot through a post-Soviet era record, pumping 11.1 million barrels a day for September. As the news of the OPEC agreement broke, the market was forced to account for what would be an offsetting increase in supply of up to 400,000 barrels of Siberian oil.

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If OPEC stays true to the agreement, the market will rebalance far quicker than most analysts were expecting. All eyes will once again be on US rig counts in anticipation of renewed shale and unconventional output.

Venezuela and Nigeria at least, along with other struggling petrostates, will take short-term relief in the recovery in price. The conversation is by no means over, but it does appear, at least for the moment, that global oil markets are no longer unmanned.

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