The Hindu Business Line
Deals to cut output spark crude oil rally
Compliance will be key though; cap on prices likely
Crude oil, routed since June 2014 from $115 to less than $50 a barrel until recently, found respite over the past fortnight. Prices shot up nearly 20 per cent since November 29 from about $46 to $55 a barrel, an 18-month high.
The rally has been sparked by agreements among major oil producers to cut output. First, on November 30, the Organization of Petroleum Exporting Countries (OPEC) , led by Saudi Arabia agreed to cut production by 1.2 million barrels a day.
Next, on December 9, 11 nonOPEC countries, including mega producer Russia, agreed to join hands with OPEC and cut output by about 0.6 million barrels a day. These cuts, totalling about 1.8 million barrels a day, account for nearly 2 per cent of global oil output. These cuts are to be implemented initially for six months from January 2017. This should help ease the global oversupply that had contributed to oil prices falling off the cliff.
Together, these OPEC and nonOPEC producers account for about 60 per cent of the world’s oil supplies. This is the first deal by OPEC to cut output since 2008 and the first between OPEC and non-OPEC since 2001. Among OPEC countries, Saudi Arabia will take the largest cut (nearly 0.5 million barrels a day). Russia will cut about 0.3 million barrels a day, the most among non-OPEC nations.
Saudi Arabia has signalled its readiness to cut more than agreed. This could take its output to below the psychologically important level of 10 million barrels a day. This marks a shift in the Saudi strategy in its highstakes standoff with US shale oil producers.
The sharp rise in shale oil output in the US, aided by hydraulic fracking, was a key reason for the oversupply in the crude oil market since 2014. Rapid growth in domestic output in the country saw its imports plummet, helping to turn it into an exporter.
The OPEC, dominated by Saudi Arabia, responded not by cutting output to support oil prices, but instead by maintaining and even increasing production levels. This exacerbated oil’s fall. The Saudi strategy was to maintain market share through low prices, while making it unviable for US shale oil producers to continue in business.
To an extent, the strategy worked with some US producers being laid low. But others continued to drill, aided by technological improvements that lowered their cost of production. In effect, the US shale industry is holding up despite the strain, a sign that the Saudi strategy was not yielding the desired results.
Meanwhile, low prices also put heavy stress on OPEC members such as Venezuela and Saudi Arabia itself (despite its deep pockets). With pressure building up, the Saudis, after holding out for more than two years, decided to change tack from a low-pricehigher-volume strategy to a better-price-lesser-volume approach. The Russians, too, under strain from Western sanctions, seem to have decided in favour of better prices. Both Saudi Arabia and Russia depend heavily on oil export revenue.
The Trump factor
The change in the Saudi approach could also have been accelerated by Donald Trump’s election as the next US President. Trump’s ‘America First’ worldview and his pro-business leanings will likely mean financial incentives, tax breaks and easier land and environmental clearances for US shale oil and gas producers.
This could help them compete even at lower prices. Shale has helped the US secure energy independence, adding to its geopolitical heft; it is unlikely to let go of this advantage.
Still, the recent deals to cut output have been tough to sew up and could be tougher to implement. Iraq has agreed to cut production. But Iran, the other big producer in OPEC and a longterm Saudi Arabia adversary, has been allowed to raise output given its post-sanctions status. This would have been hard for the Saudis to digest. Others such as Libya and Nigeria have been exempt from cuts due to disturbances there.
Also, what will really matter is compliance. There have been instances in the past of oil producers not keeping their word. The temptation to raise oil production will increase with a rise in prices.
Even if the deals are sustained and oil prices rise, there will likely be a cap around $60 a barrel. At this level, many US shale oil producers could make a comeback. Major producers such as the US, Brazil, China and Canada are not part of the recent deals to cut output. A rise in output in these countries could cap oil prices.