Exactly two years after Saudi Arabia coaxed its fellow OPEC members into letting market forces set oil prices, it has performed a nifty half-pirouette. On Nov. 30 it led members of the oil producers’ cartel in a pledge to remove 1.2 million barrels a day from global oil production, if non-OPEC countries such as Russia chip in with a further 600,000 barrels a day. That would amount to almost 2% of global production, far more than markets had expected. It suggested that OPEC is not dead yet.
The size of the proposed cut, the first since 2008, caused a surge in Brent oil prices to above $50 a barrel. Some speculators think that it may mark the beginning of the end of a two-year glut in the world’s oil markets, during which prices have fallen by half and producers such as Venezuela have come close to collapse. As long as prices continue to recover, Saudi Arabia probably can shrug off the fact that its previous strategy damaged OPEC at least as badly as it did non-members, and that this week’s deal gives more breathing space to its arch-rival Iran than it would have liked.
Since the end of September, when OPEC sketched out a deal in Algiers to cut production, Oil Minister Khalid al-Falih of Saudi Arabia and his Iranian counterpart, Bijan Zanganeh, had engaged in a game of brinkmanship that at times seemed likely to doom this meeting. Oil prices have staged frenetic swings since then. Days before the Vienna gathering, some analysts gave it a mere 30% chance of success. The betting was that failure would push prices well below $40 a barrel, and possibly bring about the collapse of OPEC.
However, Saudi Arabia, OPEC’s biggest producer, realized that pragmatism was its best option. Its promised 4.6% cut in production is mirrored by many other OPEC members, though Iran was permitted a token increase as it recovers from nuclear-related sanctions. That may be galling for Saudi Arabia, but it is likely to benefit far more than Iran from the rise in oil prices, if sustained, than it will lose from lopping 486,000 barrels a day off its total output. It promises to cut to 10.05 million barrels a day, which is not far below its level in the first quarter of 2016.
Moreover, the government’s plans to modernize the economy and partly privatize Saudi Aramco, the state oil company, depend to some extent on higher oil prices, said Bhushan Bahree of I.H.S. Markit, a consultancy. Counter-intuitively, he said, the kingdom needs higher oil revenues as “a bridge” to becoming a less oil-dependent economy. OPEC argues that a modest cut now will spur investment in new sources of crude that will prevent harmful oil shortages in the future.
The cuts will take effect as of Jan. 1 and will last for six months. During that time traders will monitor oil-tanker traffic to ascertain whether fewer are leaving port. They cannot monitor Russia’s pledge to cut 300,000 barrels a day of production, however, because much of its production moves by pipeline, noted Abhishek Deshpande of Natixis, a bank. Nonetheless, he believes that the agreement will start to cut global oil inventories next year. Non-OPEC output has fallen this year, adding impetus to the cartel’s efforts.
© 2016 Economist Newspaper Ltd., London (December 3). All rights reserved. Reprinted with permission.
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