In a landmark agreement thrashed out at a November meeting in Vienna, oil cartel Opec has agreed to cut supplies for the first time since the global financial crisis, causing prices to soar to the $50-a-barrel mark. The 13-member-strong cartel is responsible for pumping a third of the world’s oil, so the announcement that it would cut production by around 4%, equating to a reduction of 1.2m barrels a day, was big news on the markets.
The agreement represents an about-turn for Saudi Arabia, which has been committed to rising output over the last two years in a bid to torpedo the profits of US shale and other high-cost producers. The new cuts are designed to push prices upward from a $50 floor.
In the wake of the announcement, the S&P 500’s oil and gas exploration and production index — mostly comprising US shale companies — rocketed 10.8 per cent by early afternoon in New York, its highest level since mid-2015. But almost all US energy companies benefited from the outward ripples, jumping by around 5.5 per cent.
Broad support for production cuts
Saudi Arabia will shoulder the bulk of the cuts, while conflict-hit Libya and Nigeria were granted exemptions. Other non-Opec producers, including Russia, agreed to participate in the agreement by lowering their production but it’s not clear where the additional cuts will come from – Azerbaijan, Brazil, Kazakhstan, Mexico and Oman are among the biggest producers outside of the cartel.
Russia, which produces roughly equivalent supplies to that of Saudi Arabia, is alleged to be part of the new arrangement, but analysts doubt the commitment as oil revenues make up most of the Russian government’s income.
Opec hopes the deal will help the oil market recover from its longest downturn in a recent memory, which has hit the share prices of oil companies and sent big producing countries spiralling into recession.
Impact on US producers
The US industry has had to streamline its approach over the last two years in a bid to remain profitable. Efficiency savings have included many job losses along the way. Prior to 2014, many firms struggled to make a profit when oil was $70 a barrel but are now able to remain competitive at much lower prices. Businesses are still cautious about the Opec agreement and its ability to hold together.
Analysts fear that a general lack of global demand for oil will continue to exert downward pressure on prices. There’s also speculation over whether the members of Opec will stick to the rules or may be tempted to start pumping more oil than their agreement allows.
Saudi Arabia has suffered during two years of self-imposed low prices in a bid to hamstring US frackers. But the US industry has been surprisingly resilient and the Saudi economy has been the one to suffer, with broad cuts to services.
Few expect the oil business to return to its glory days when $100 a barrel was the norm. A more likely outcome is the emergence of a $60 cap, as shale output increases and Opec’s once-impenetrable control over the industry is gradually eroded.