Will OPEC’s Decision to Cut Production really Help Oil Prices to Move Up?

For the first time since 2008, the OPEC at its Vienna meeting on November 30th decided to put supply restrictions. In fact, the OPEC went one step ahead. It also agreed upon the sharing of production cuts among the OPEC member nations. But, the question is whether it will really prop oil prices?

What is the net impact on supply?

The OPEC members have agreed to cut output by a total of 1.2 million barrels per day (bpd) to 32.5 million bpd. The irony is that it is still almost 3 million bpd higher than the level of OPEC production in 2014, when the crash in oil prices started. Therefore any immediate and large impact on supply may be ruled out. Secondly, while OPEC will cut supply by 1.2 million bpd, there will be another 700,000 bpd of Indonesian quota that gets reallocated. That leaves a net reduction in supply of just about ½ million bpd. That is surely not enough to impact a daily global output of over 90 million bpd.

Will the deal sustain?

That remains the billion dollar question! Even in the past, the OPEC nations had gotten close to a supply cut but that never really worked. The big challenge will be how to monitor adherence to these limits. In the Middle East and West Asia there is a large black market for crude oil and tracking that will be extremely difficult. Also, any geopolitical tension in the Middle East may force nations like Iran and Iraq to abandon the quota. Sustaining and monitoring the quota will largely depend on the ability and willingness of Saudi Arabia.

How about the US and Russia?

Other than Saudi Arabia, the US and Russia are the 2 largest producers of oil. These 3 countries account for 1/3rd of global oil production. For the OPEC quota to succeed two things are essential. Firstly, Russia needs to walk its talk on oil prices, despite its own conflict of interest. Secondly, higher prices of oil must not end up making US shale wells profitable. If that happens, the entire purpose of the OPEC production cut may be defeated.

Where is Brent headed?

The price of Brent Crude sharply moved up from $46/bbl to $53/bbl in a span of just 2 days since the OPEC supply cut announcement. However, the Brent crude market may be overestimating the impact of the supply cut for 3 reasons. Firstly, the OPEC just accounts for 31% of global oil output and therefore its influence is substantially lower than before. Secondly, the world still has stockpiles to the tune of 8 billion bbl and that will put a cap on oil prices. Lastly, the demand side is hardly showing any buoyancy and that is unlikely to change in the near future. For now, oil prices may be again headed below $50/bbl!

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