Yahoo Finance Opec doesn’t hold all the cards, even after its oil price agreement
The cartel’s deal hammered out in Vienna may put a floor under the price of crude, but Saudi Arabia has failed to destroy the US fracking industry
Two years of wrangling were needed before Saudi Arabia and the rest of the Opec oil cartel could agree a cut in production at its meeting in Vienna last week.
Ever since the collapse in crude prices in 2014, the big oil-producing countries have plotted a way to regain control and improve their battered finances. But agreeing which countries would bear the pain of the steepest production cuts had proved an insurmountable challenge.
That barrier proved less formidable once prices stayed persistently low into 2016. With a recovery in the crude market nowhere in sight, finally one member after another fell into line at Vienna – and crucially Russia, a non-Opec producer, agreed to a cut of its own.
It means that for UK motorists the days of £1-a-litre of petrol are likely to fast become a distant memory.
It was only back in January that the price of a barrel of Brent crude tumbled towards $27 and some analysts forecast that it could reach as low as $10. There was joy among western leaders who dared to believe that the era of stellar economic growth that characterised the 1990s, fuelled as it was by super-low oil prices that rarely pushed above $20 a barrel, was about to return.
But a long run of ultra-cheap prices was not to be; Brent quickly bounced back and spent the rest of the year moving between the $40-$50 mark. None the less, Opec, which produces a third of the world’s crude oil, wanted more and announced that it would cut production by around 4%, or 1.2m barrels a day, to bring output down to 32.5m barrels a day in January. The cut is an effort to put a $50-a-barrel floor under the price and push it towards $60 a barrel within a few months.
Mihir Kapadia, chief executive of fund manager Sun Global Investments, says: “Oil prices are truly on course for a recovery. The first coordinated action by the Opec members in eight years has definitely set a new price outlook for the commodity. The longer-term impact on oil price will depend on the implementation of the accord, and discipline in sticking to the accord.”
But few in the oil business expect a return to the prices which dominated the early part of the decade, including the most recent peak of $114 two years ago. It is more likely that a $60 cap will emerge as the Americans, who stand outside the 13-member Opec grouping, unplug the spigots that have kept their shale oil fields from producing in the last year or two. It is the emergence of shale drilling – where pumping a mixture of chemicals, water and sand into dense rock releases trapped oil – that has prevented Opec from controlling supply and demand in the way it did in the past.
“Global, and especially US, crude oil inventories are currently at extremely high levels after two years of massive oversupply,” Société Générale analysts say. “While the Opec agreement is very significant and will result in some moderate global stockdraws next year, it is likely to take more than one year for crude inventory levels to return to more normal levels.”
The return to action of once-idle derricks on the Texas and Dakota plains is the result of efficiency savings that have seen large jobs losses and a more streamlined approach to drilling from the US industry, after the post-2014 price tumble rendered many operators unprofitable. Only a few years ago, many firms struggled to make a profit at $70 a barrel. Now they can be competitive at much lower prices, with many expecting $50 for West Texas Intermediate – a lighter crude that typically earns $5 a barrel less than Brent.
Since the start of June about 25 US oil rigs have been moving into the market every month. Most firms report taking a cautious approach to give themselves time to assess the Opec agreement and whether it will hold.
Analysts at Oxford Economics say the US shale industry is right to be wary. It says a general lack of global demand for oil is another downward pressure on prices and will keep them below $60 a barrel, at least until the end of 2018. A history of Opec governments cheating to improve their revenues – by pumping more oil in contravention of production cuts – is also likely to undermine efforts to cut output, they say.
Saudi Arabia, which has long been the main producer and most powerful political operator in the Opec cartel, has dug deep into its reserves to make up the shortfall in its public finances following two years of low prices. It hoped to cripple the US frackers by holding down prices. Under that plan, it would then have ratcheted them up again with a well-timed production squeeze. But the US industry has not collapsed and Saudi Arabia has seen its budget ravaged as prices stayed low, forcing an embarrassed King Salman to cut subsidies and services.
In the wake of the Vienna agreement, Saudi Arabia will lead the way with reductions of 0.49m barrels a day, with Iraq, the United Arab Emirates and Kuwait taking smaller hits. Other minor reductions have been promised by Algeria, Angola and Venezuela, while Iran – which faces the reinstatement of sanctions by an incoming Trump presidency – was allowed to freeze or marginally increase output.
Last Friday, the new strategy appeared to be working. The spot price of Brent crude managed to break out of the $43-$54 range that has been the norm since mid-April, giving a lift to the revenues that oil producers crave.
But with the US shale producers still in play, the move is likely to put a floor under the price only, not send it into the stratosphere.
Oxford Economics says that, cheating aside, weak demand due to the state of the global economy is one of the biggest barriers to high prices. The fragility of the Vienna deal, and the six-month timescale to implement it, are another two elements keeping forecasts muted.
Russia, which is not an Opec member and produces about as much oil as Saudi Arabia, counts as a further reason for caution. It is supposed to be part of the new arrangement, and officials in Moscow are scheduled to announce production cuts next week. The press conference is likely to go ahead, but analysts are sceptical there will be a significant move to cut production when oil revenues make up most of the Russian government’s income.
Joshua Mahony, market analyst at spread betting firm IG, says: “A likely rise in US output, in response to higher prices, and an increasing rig count will counteract some of [the production] cut, while the opaque nature of national crude output mean that enforcement will be unreliable at best.”
Enforcement of the Vienna deal is the key to preventing oil prices from falling again. But the interaction of supply and demand, most of it outside Opec’s control, means that for the next couple of years, prices are probably going nowhere fast.
Who benefits?
WINNERS
BP and Shell The prospect of a cut to production from January lifted oil prices last week and with them the shares of energy companies. Royal Dutch Shell and BP were the biggest gainers in the FTSE 100 on the day of the deal, on predictions oil could climb to $60 a barrel.
Nicola Sturgeon The prospect of higher oil prices should bring some relief to Scotland’s first minister. More than a year of oil prices around or below $50 has put pressure on the North Sea oil industry. Crude in the region has become increasingly tricky to reach and lower returns make investing in oil extraction harder to justify. That in turn has cost jobs, hit tax receipts and blown a hole in Scotland’s public finances. Scotland’s deficit ballooned last year as its share of North Sea oil tax revenues collapsed to £60m from £1.8bn the previous year.
Shale A combination of weak demand and a decision by Saudi Arabia to keep production levels high had pushed oil prices down sharply since the summer of 2014. Riyadh’s hope was that low crude prices would push higher-cost US shale producers out of business. But it didn’t: and now that prices have risen, shale fields in the US are expected to ramp up their production.
LOSERS
Motorists Petrol prices are set to rise after the Opec deal sent crude surging. In the UK, petrol costs could increase by as much as 9p a litre, adding almost £5 to the cost of filling up an average family car, according to motoring organisations. Higher oil prices could also push up household energy bills as wholesale gas tends to track the price of crude. But petrolheads’ loss could well be environmentalists’ gain, if higher pump prices push people towards electric cars or just into driving less.
Saudi Arabia The kingdom flooded the markets with cheap crude in a bid to kill off US shale, but now it has effectively admitted defeat; Saudi is bearing the brunt of Opec’s production cut. On the other hand, it stands to gain a little from a higher oil price: that would offset some of the pain from production cuts and make the stake in state oil producer Aramco, which it is planning to float, more valuable.
Airlines Carriers have benefited from cheap fuel over the last two years but now their costs look set to start rising again. Shares in airlines, including Ryanair and easyJet, fell as Opec reached its deal.
Katie Allen
