OPEC Clinches Major Deal to Normalize Crude Inventory

OPEC to reduce output by about 1.2 million bpd from January 2017

o1Weeks of tense negotiations gathered momentum and gave way to an optimistic and upbeat mood as the Organization of Petroleum Exporting Countries’ (OPEC) ministers gathered in Vienna on November 30th, 2016, to close a deal to cut oil production in an effort to prop up global crude oil prices, as reported by Bloomberg. By clinching a major deal to normalize record global oil inventories, OPEC baffled naysayers, sending crude oil prices soaring when members agreed to its first production cut in eight years. Since the September 2016 meeting, crude oil prices have been trading near $48 per barrel, up from under $30 a barrel at the start of 2016, but well down from the years when it was above $100 a barrel, before dropping off in mid-2014.

OPEC scored a major triumph when it was able to patch up disagreements between the group’s three largest producers, Saudi Arabia, Iran, and Iraq, and end a free markets era that started in 2014. Most strikingly, non-OPEC nation Russia and the largest oil producer in the world, agreed to unprecedented cuts to its own output for the betterment of the overall oil industry, marking the first coordinated action with Russia in 15 years.

As reported in our earlier coverage, OPEC was under pressure to reach an agreement to stabilize the market and eliminate the global oil glut, where crude remained capped below $50 a barrel. OPEC, which met on the sidelines of the International Energy Forum (IEF) in Algeria from September 26-28th, 2016, agreed to reduce oil output to 32.5 million barrels per day (bpd) from the current levels of around 33.24 million bpd, driving a spike in crude prices since then.

Source: Bloomberg
Source: Bloomberg

OPEC ministers met on November 28th, 2016, to iron out several disagreements, mostly among Saudi Arabia, the largest producer, and Iraq and Iran, on how to share the burden of supply cuts. Geo-political tensions between Iran and Saudi Arabia were the main stumbling block to reaching an oil output curbing agreement among the OPEC nations. An oil production cut would help the oil price to rise to $55 to $60 a barrel; however, if no agreement was reached, oil prices would remain below $45 a barrel or plunge lower as the global glut increases.

Crude jumps 10% on OPEC deal

Reacting to the news, benchmark oil prices gained as much as 10% in New York and the share prices of energy companies around the globe jumped alongside a basket of major currencies of large oil exporting nations. The sustenance of elevated crude prices will however depend on how strictly OPEC members will stick to the agreement reached on November 30th, 2016, something that they have not always done in the past.

Source: Bloomberg
Source: Bloomberg

Meanwhile, economists have warned that crude oil prices could recede over the next few months as other producers, especially U.S. shale drillers, are standing ready to fill the supply gap. U.S. crude production has already risen by more than 3% in 2016 to 8.7 million bpd, as its drillers have slashed costs in an effort to compete in a lower price environment.

OPEC will reduce output by about 1.2 million barrels a day from January 2017, fulfilling a plan sketched out in Algiers in September 2016 to cut its production to 32.5 million barrels. The agreement exempted Nigeria and Libya, but gave Iraq its first quotas since the 1990s. Iran was allowed to raise output to about 3.8 million bpd, as it is yet to recover from sanctions. Saudi Arabia previously proposed that Iran should limit output to 3.70 million bpd.

Saudi, Iraq to cut output

Saudi Arabia, OPEC’s largest producer which raised oil production to a record this year, will reduce output by 486,000 bpd to 10.058 million bpd. Iraq, OPEC’s second-largest producer, agreed to cut by 210,000 bpd from October 2016 levels. Iraq had earlier asked for special consideration, citing the urgency of its offensive against Islamic State.

The United Arab Emirates and Kuwait will reduce output by 139,000 bpd and 131,000 bpd, respectively. Non-member Russia, also pumping at post-Soviet record levels, will cut by as much as 300,000 bpd, but conditional on its technical abilities. Indonesia requested a freeze of its OPEC membership; however, its suspension will not affect the group’s production cut.

Focus shifts to Doha meeting

Russia, the biggest producer outside the bloc, had previously resisted calls to trim its production, insisting it would only consider a freeze at current output levels. OPEC plans to hold another round of talks with non-OPEC producers next week in Doha.

OPEC will earn $341 billion from oil exports in 2016, according to the U.S. Energy Information Administration, down from $753 billion in 2014 before prices crashed, and a record $920 billion in 2012.

The strength of the deal will depend on whether all parties deliver on their commitment. Saudi Arabia and its Gulf allies, the U.A.E. and Kuwait, have traditionally stuck to their cuts, but some others have not, particularly when prices are low. Any doubt in the market could once again see prices come under pressure. OPEC will meet again on May 25th, 2017, at which point it intends to extend the cuts by another six months.

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