Oil prices soar as OPEC agrees to curb production for the first time in 8 years. Will the rally last?
OPEC is an intergovernmental organization of 13 member countries, founded in 1960. As of 2015, OPEC nations have accounted for an estimated 43 percent of global oil production, giving it a major influence on global oil prices.
However, of the top 4 oil producers, only Saudi Arabia is an OPEC nation. This lack of bargaining power in the public eye has constantly casted frequent doubt on the influential power of the international cartel.
Speculation on how it was near impossible for OPEC to cut its oil prices was due to the simple factor of market share.
Even if members within the bloc cut production, countries such as Russia and the United States, who are outside the cartel, may still continue to produce at their preferred record levels, causing countries from within the OPEC to lose market share, and consequently hindering the ability of the group to improve oil prices.
Immediate impact on the energy world
Oil prices soared on Wednesday, 30th November 2016, to its highest in a month at over $50 a barrel, as the world’s largest producers agreed to curb production for the first time since 2008.
OPEC will reduce output by about 1.2 million barrels a day by January 2017 according to an agreement finalized in Algiers in September 2016 to cut its production to 32.5 million barrels.
The deal, aiming to drain global oil inventories, overcame disagreements between the bloc’s three largest producers: Saudi Arabia, Iran and Iraq. What was even more astonishing about this deal was how broad this cut had extended to.
Most strikingly, Russia agreed to the unprecedented cuts to its own output, causing a sizeable impact on oil prices as it soared by as much as 10 percent in New York and also had the knock-on effect of energy companies' share prices around the world jumping alongside it.
On the international stage, the move by OPEC and the successful agreement between its largest oil nations as well as Russia had proved many of OPEC’s doubters wrong.
“This should be a wake-up call for skeptics who have argued the death of OPEC,” said Amrita Sen, chief oil analyst at Energy Aspects Ltd. “The group wants to push inventories down.”, Bloomberg reported.
Some argue that it is a bullish deal
However, some analysts have also argued about the longevity of this deal itself and how the adherence to the deal would be vital to the extent of how successful the agreement would be.
The United Arab Emirates and Kuwait will reduce daily output by 139,000 barrels and 131,000 barrels respectively. Russia, who is not part of the international cartel, is currently pumping at a post-Soviet record level, but will cut this by as much as 300,000 barrels a day “conditional on its technical abilities,” Energy Minister Alexander Novak said in Moscow.
Though most political statements made in public tend to be vague and don’t necessarily contain much concrete information, the hesitance in providing a definitive answer regarding Russia’s ability to cut oil production caused many to doubt the effectiveness of the agreement itself.
“What was announced so far is bullish, but January is still far away,” said Giovanni Staunovo, an analyst at UBS Group AG. “December will still see ongoing record production, but market participants might ignore it. It does seem as though Russia will cut, which if implemented is also positive.”
It is however, of no doubt that the strength of the deal will depend heavily on whether these parties, both within and outside the bloc, will deliver and stick to their trade.
The production capabilities and their decision to veer away from coinciding with the agreement would mute the price reactions.
While prices may climb further in the near term, like the 10 percent jump since the announcement of the agreement, the improvement in prices may be short-lived if countries that are not involved in this agreement, such as the USA and Indonesia, ramp up their production instead to exploit these higher prices.
Southeast Asia – Indonesia suspending its OPEC membership
In Southeast Asia, OPEC’s only East Asian member, Indonesia, has suspended its OPEC membership, less than a year after re-joining the cartel, as the Southeast Asian importer said it could not agree to the group’s production cuts.
In the agreement, OPEC had proposed that Indonesia cut production by 37,000 barrels per day, which is equivalent to 5 percent of its output.
However, Indonesia’s Energy and Mineral Resources Minister Ignasius Jonan, had stated ‘the only reduction the East Asian nation could accept was a cut of 5,000 barrels per day’, which is far from the number OPEC had proposed.
This resulted in the temporary suspension of Indonesia’s membership with the cartel. Being the only member not to participate in this ground breaking deal, this had caused further speculation on the patchy relationship Indonesia has with OPEC, given its already disjointed history.
“If we participated we would cut 37,000 barrels, and that’s worth US$ 2 million daily, APBN would be affected,” Luhut Binsar Pandjaitan said on Thursday, as reported by Reuters.
The oil industry is a vital part of Indonesia’s economy and this temporary suspension might be seen as a strategic step for the archipelago. With Indonesia not reducing production output, they could exploit these higher prices as a result of the cut by the cartel, and effectively boosting their national wealth.
The effect of this freeze, would mean Indonesia could prevent a daily US$2 million loss, which could potentially benefit Indonesia’s economy, and Southeast Asia as a whole.