OPEC’s oil cut deal and its implications

-Smera Chawla


In September 2016, the Organization of the Petroleum Exporting Countries (OPEC), a cartel of oil producers came to a tentative agreement to moderately lower the oil production to stabilise the plummeting oil prices globally. Price of a barrel of Brent crude was as low as USD 27 in January this year and some analysts gave the figure of USD 10 a barrel in future.  Countries which would be cutting down the production was to be decided in the November 30th meeting that was supposed to take place at OPEC’s headquarters in Vienna.  Under the agreement signed in Algiers in September, cartel members decided on the details of trimming production by up to 700,000 barrels a day (b/d), from current level of just over 33 million b/d. However, the proposed cut represents less than 1 per cent of the total global production, thus barely reducing an oil excess responsible for dipping oil prices. 

After eight years since the financial crisis in 2008, the OPEC has for the first time considered cutting down oil production. During the financial crisis of 2008, oil prices had dropped. OPEC’s decision in November 2014 not to cut production in response to the global surplus triggered the price collapse which has been more persistent. OPEC had adopted this policy to keep pressure on higher priced producers like the United States of America and Canada.

Point of Conflict between Iran and Saudi Arabia

Dispute between the two Middle Eastern nations has deep religious, historical and political roots. Saudi Arabia and Iran have been on the opposing sides of a more than 1,000-year old argument of Islam – between Sunnis and Shia. Saudi Arabia has a larger majority of Sunni Muslims, while Iran has Shias. In addition, to religious disputes, tension between the two countries escalated when Saudi Arabia backed Iraq’s Saddam Hussein, and after clashes at the hajj in 1987 hundreds of Iranian pilgrims were killed. Saudi Arabia had suspended diplomatic ties with Iran for three years. The two countries are also on opposing sides in major conflicts, like the Syrian civil war.

Now, it is clear from the OPEC agreement that Saudi Arabia, the second largest OPEC member (also the dominant one) wants to keep the oil prices from further weakening. Saudi Arabia’s government budget deficit was projected to nearly last year’s total of USD 98 billion, which forced them to take austerity measures and borrow on international credit markets.

In January 2016, International Atomic Energy Agency lifted international sanctions on Iran following Iran’s successful compliance with a deal designed to prevent it from developing nuclear weapons. Post the lifting of sanctions, Iran had taken a stand that it should be allowed to increase the oil production after years. Earlier this year, Saudi Arabia made an attempt to freeze production because Iran declined to participate. From September to November, Iran got time to increase oil production significantly from the current levels.

State of Play

Following the Vienna agreement, Saudi Arabia will be at the forefront with reductions of 0.49m b/d. Iraq, the United Arab Emirates and Kuwait are keeping smaller targets. Other OPEC countries such as Algeria, Angola and Venezuela have also committed to minor cuts in the oil production. Iran which faces reinstatement of international sanctions by the Trump presidency – has been allowed marginally to increase the output.

The success of Vienna agreement will be assessed by the cooperation from non-OPEC members. Russia, a non-OPEC member produces as much oil as Saudi Arabia and thus, counts for a reason for caution. The Vienna agreement, supposedly, includes Russia and officials in Moscow are expected to announce the reduction in production levels soon. However, Moscow is a hard nut to crack and could be a game spoiler.

As of now all the non-OPEC members apart from Russia have agreed to cut output by 562,000 barrels a day.

Impact of the OPEC Agreement

Energy companies such as Royal Dutch Shell and BP are expected to benefit from the agreement. They were the biggest gainers in the FTSE 100 on the day of the deal. Scotland too is expected to be one of the gainers. With oil prices being around or below USD50 for two years an immense pressure has been put on the North Sea oil industry. While the exploration costs have gone up in the region, lower returns make the investment in the upstream business hard to justify. This has led to job cuts, hit tax receipts and created an imbalance in Scotland’s public finances. Scotland’s deficit increased significantly last year as its share of North Sea oil tax revenues collapsed. With the Paris agreement and the shift towards clean energy, increasing oil prices is going to further bolster the renewable energy sector. With the world heading towards a paradigm shift towards wind, solar, natural gas and shale gas, the clean energy producers are expected to gain heavily.

The cuts take effect from January 1st, 2017 and Saudi Arabia is likely to bear the brunt of OPEC’s production cut. Experts suggest that Saudi Arabia’s plans to modernise the economy and partly privatise Saudi Aramco, the state oil Company, depends to some extent on high oil prices.  With the objective of becoming a less oil-dependent country, the kingdom needs higher oil revenues. 

Largely, the industry experts feel that the OPEC oil agreement is likely to be short-lived. People in the oil business don’t expect a return to the prices that dominated at the beginning of the decade, including the peak of USD 114 two years ago. It is expected that following the Vienna agreement, Americans who stand outside the 13-member OPEC cartel will reinitiate the shale drilling. If oil prices continue to rise, American shale producers will increase the output and OPEC’s best efforts to kill shale industry will go in vain.

For now, crude oil prices are firming up on improved sentiment riding on hopes that the OPEC members will stand by their commitments to enforce cut in the production. The non-OPEC members also seem to be realising the importance of a coordinated approach towards stabilising the prices or else they would all lose. Thus, it is expected that Brent crude oil prices will reach USD 60 b/d by 2017 end.