The decision, last week, by member countries of the Organisation of the Petroleum Exporting Countries (OPEC) to trim global oil production by 1.2 million barrels per day (mb/d) was much trailed — a little over 2 months ago, at a meeting in Algiers, OPEC had hinted at the possibility of a quota cut. Nonetheless, the oil cartel’s decision, November 30th, caught most market watchers by surprise, bumping Brent Crude prices past US$50 per barrel.
Ahead of the meeting, there were worries about how OPEC was to square the Saudi push for lower production levels with the needs of an Iran (only just emerging from U.S.-imposed sanctions over its nuclear arms industry) to ramp up its oil production complexes. Much of the conversation around the respective quotas also did not answer the question around why the Saudi’s were going back on their decision nearly two years ago, to forgo higher oil prices for an increased market share. In the end, to ease the passage of the new quotas, the Saudi’s agreed to pare production by 486,000 b/d (or 4.6% of the kingdom’s current production levels) to 10.05mb/d — Iran, the meeting decided, could nudge production up a bit.
Higher oil prices matter for most OPEC members. The glut in the market, and the resulting halving of prices since mid-2014 have hurt most of its members’ fiscal positions. Venezuela and Nigeria have been scraping at the bottom of their financial barrels looking for scraps since the oil market tanked, and stand to gain a lot from any price recovery. In addition, much of OPEC’s north African membership have been racked by political upheavals that may be placated were the respective countries to earn more from oil sales. Finally, even the Middle East itself has been scathed by sub-US$50 per barrel oil.
So, what to make of the current agreement? First, much of its impact would depend on non-OPEC countries agreeing at a meeting, later this week, to lop 600,000 b/d off global production. Then, OPEC’s new quota agreement doesn’t come into effect until January 1 2017, allowing members to ramp up production meanwhile. Third, most OPEC countries are producing at full capacity already, as indeed Russia is. Thus, the agreement is not so much a cut, as the imposition of a lid on further breaches of current record production levels.
This leads to the fourth consideration in this string of thoughts: what impact, if any does this agreement have on the global glut in oil supply (estimated at anything from 1.5mb/d to 3mb/d)? The unwinding of the long-running excess of supply over demand, including how funds that have bet on oil react to the recent cuts would matter for oil’s near- to medium-term outlook. Much more important, though, would be how U.S. oil responds to higher prices, especially given a new president committed to oil self-sufficiency. The biggest cap on oil prices will be how oil producers in the U.S. respond to the effects of OPEC’s production gambit.
However, to look at the oil industry from the supply side alone, is to miss the nature and degree to which the market for this commodity has changed. Softer global output growth, in the U.S. and China more than most, coupled with a fall in global trade as a share of global output is always going to mean that the demand for crude oil is waning. A pick up in the U.S.’ economy (Donald Trump’s higher infrastructure spend, or lower tax rates) or in China’s (hard to tell from here, where this will come from) could reverse this prospect, boosting the demand for oil and supporting relatively elevated prices. Add to this, the fact that the U.S. looks like becoming a net exporter of heating fuel (LPGs) next year, for the first time in 60 years.
For four reasons, though, were it to occur, this latter possibility is always going to be a short-term uptick: improvement in the energy intensity of global production; an increasing share of renewables in global energy production; and the slow but inexorable rise of the electric vehicle (Wood Mackenzie Ltd., an oil industry consultant, estimates that by 2035, electric vehicles could wipe out as much as 10% of the global demand for petrol). Irrespective of what happens on the 1st of January next year, and six months after, when OPEC is scheduled to take another look at the agreement, the truth is that global oil is in long-term decline. It is of scant help that, as Ali al-Naimi, Saudi Arabia’s former oil minister reminded the world last week, OPEC members are notorious for breaching deals of this nature.
Interestingly, one argument for the Saudi’s renewed interest in higher oil prices is that they have now realised that they would need to find financing for their post-oil plan: higher oil prices would make the planned Aramco divestment even more lucrative to begin with. Is there a lesson in this for other oil producers? Kind of: oil is a commodity with a great future behind it!