Late on Wednesday, Opec announced a deal more far reaching and with greater participation than anyone expected. Whereas Opec had targeted cuts of 200,000 to 700,000 barrels per day in late September, the producers' group pulled a 1.2 million bpd rabbit out of the hat. True, the increased cuts only put production back where the Saudis were hoping in September, but cobbling together such a programme constitutes both a major effort and shining achievement.
Importantly, the agreement was largely balanced, with cuts of 4.6 per cent essentially across the board. As anticipated, Libya and Nigeria were exempt, as both are struggling with outages that are the result of war, sabotage and insurrection. Indonesia was sent packing, its membership in Opec suspended. An oil importer like Indonesia is going to feel out of place in the Organization of Petroleum Exporting Countries.
Iran also received special dispensation, winning permission to raise production to 3.8 million bpd. But otherwise, everyone else kicked in. Or was kicked around. Iraq took a few blows, as its claims for additional production to fight ISIL fell on deaf ears. Indeed, Iraq has been reclaimed by Opec from which it had been either excluded, under Saddam Hussein, or exempt as it tried to rebuild its economy and oil exports after the fall of the dictator. The go-go days of headlong Iraqi oil production growth may be over as Opec reasserts control over its production possibilities.
The second- and third-tier Opec countries – Algeria, Angola, Venezuela, Ecuador and Gabon – all promised to toe the line. Even more intriguing was the broad participation of non-Opec members. Russia, which had offered only a freeze, appeared to accept a cut of 300,000 bpd. This was a linchpin to the deal. Had the Russians held their recent high production levels, the Saudis would have felt cheated of market share and the deal could have died right there. But the Russians stepped up and joined Opec in a production cut. If Indonesia was sent home, Russia has all but become a member of the Opec club.
Participation did not stop there. Mexico, Oman and Kazakhstan have all offered cuts, probably in the 275,000 bpd range. Some of the cuts are self-serving. Mexico and Venezuela are struggling to hold current output and have simply offered expected declines as actual contributions to the effort. Still, a cut is a cut, even if involuntary.
Add it all up, and when the dust settles, supply reductions of 1.74 million bpd are on the cards. This is remarkable in scope and the most compelling Opec coordinated action since 1980.
That so many Opec and non-Opec countries took part speaks volumes to the travails of the oil exporters. As a group, they are ready to throw in the towel and work together to restore sanity to the market.
Will the deal work? Historically, actual compliance with agreed cuts has averaged about 70 per cent for Opec. Thus, pledges of 1.74 million bpd on paper might translate into cuts of 1.2 million bpd in practice. That’s still a big cut, and a substantial help in clearing the market. The oil cognoscenti believe this will clear global excess crude and product inventories – estimated at just under 400 million barrels – by mid-2017, with heavy draws continuing into the second half of next year. This may prove to be a bit optimistic but excess inventories could easily clear within a year.
As inventories clear, market dynamics will change markedly. If promised cuts stick, we will see a bit of a supply shock in late summer.
US shale output is unlikely to respond quickly enough to cover the emerging gap. How will Opec respond? The current deal lasts only six months and some analysts posit that production will surge as the agreement expires. On the other hand, Opec members may want to become accustomed to being other than broke and prefer to re-enter the market more gradually.
Assuming Middle East politics does not deteriorate, the success of this round may well encourage a coordinated response as Opec allocates the market, at one level, between itself and US shales, and on another among Opec members themselves. For example, if demand is to grow by 1.2 million bpd, Opec may decide to claim 800,000 bpd, which is then allocated among various members, with, say, Iran and Iraq collectively claiming perhaps 400,000 bpd of the total. As such, the current deal should be taken as transitory, intended to clear excess inventories, rather than establish permanent quotas for either Opec as a whole or any allocation among its members.
For now, Opec members can congratulate themselves on the successful conclusion of an epic deal. With it, Saudi Arabia’s oil minister, Khalid Al Falih, can lay claim to a historic achievement in Saudi oil policy, placing him among the ranks of the legendary Zaki Yamani and the enduring Ali Al Naimi. It is a big day for Saudi oil leadership, one that will be remembered in the history books.
The agreement will mark a turning point in the oil industry as it recovers from a deep and scarring recession. There is more to be done, but today, the future looks bright.
Steven Kopits is the president of Princeton Energy Advisors in New Jersey.
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