Does an OPEC cut guarantee a full recovery?

Posted by David Cheetham



At the end of last month the finishing touches were put on a deal struck by OPEC members in September that sees the organisation plan to reduce their output in an effort to support the price of oil. During the press conference in Vienna when the specifics of the agreement were confirmed by Mohammed Barkindo, the OPEC Secretary General also revealed that talks with non-OPEC countries had led him to believe they too, would participate in curbing production. Doubts as to whether the cartel would finally be able to agree on terms considering the long-standing fractious relationships between many members disappeared once the deal was announced and, with the added bonus of possible cuts outside the group, the price of oil experienced the largest intra-day jump of the year in rising by $5.


This collaboration amongst countries that hitherto struggled to agree on just about anything is clearly a positive development for the price of oil. One of the main causes of the plummeting oil price of 2014 and 2015 was OPEC choosing to pump at close to maximum levels despite a global supply glut, in an attempt to preserve long-term market share and force more high-cost producers (namely US shale) out of business. This latest news clearly marks a 180 degree u-turn in their strategy but to assume that this will precipitate a face-ripping rally back to $100 a barrel is highly optimistic and quite likely plain wrong. 


The rise in recent years of US shale production has been called a revolution in some quarters, and whilst it's still in its infancy it has caused a fundamental change to the market dynamics of oil. Increasing efficiencies which now mean a far lower break even point for these producers have lowered the price at which they will resume pumping and this acts as a significant barrier to a sustained move higher back towards $100 a barrel. Furthermore, US president-elect Donald Trump has suggested a move away from clean-energy technology and with the incoming administration appointing Tom Pyle, the president of the oil-industry-funded free-market advocacy group American Energy Alliance as his head of the Energy department, there could well be greater state support for US shale than at present.


While the price of Brent - an international oil benchmark - has risen to its highest level of 2016 in recent weeks, individual stocks haven't reacted in quite as bullish fashion. Over the past month BP, Exxon Mobil and Royal Dutch Shell have all experienced price increases, but their gains are less than that of Brent. This could be in part due to skepticism remaining over the OPEC deal, with a recent Reuters poll finding that the average forecast for Brent prices in 2016 and 2017 hasn't materially changed since the agreement was announced. Many still believe that, in a classic example of economic game theory, there remains a huge incentive to cheat on the agreement for individual countries and with little safeguards in place to ensure members comply with the levels of production announced in Vienna this eventuality remains entirely possible.


This weekend on the 10th December, OPEC members will meet with the non-OPEC counterparts, led by Russia, as they seek their contribution to erode the global supply glut. Just yesterday on the 8th December a rumour that this meeting may be moved back saw Brent shed almost 100 ticks in a matter of minutes and even though the market swiftly recovered these losses once Russia confirmed the meeting would go ahead, it serves as a timely reminder of just how vulnerable the oil price is to a sell-off should this fragile agreement come undone.

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