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The comeback

Opec's deal is a seismic moment for the oil market. But forces beyond the group's control will decide how effective the cuts are

Kill the theories of Opec's demise. In one swoop on 30 November, the group has ended years of inaction, solved a raft of thorny internal problems and put itself back in the market's driving seat. Two years ago, on the eve of the fateful November 2014 meeting that would see Opec refuse to shore up a plunging market, a Saudi official said the kingdom was taking its "hands off the tiller". Now it wants the wheel back. The market has a new floor above $50 a barrel, and Opec will defend it. Call it the Falih Put.

The deal on 30 November, coming just two months after the Algiers Opec meeting that promised action and eight years after the group last cut output, means the market now has a prop. Opec will cut 1.166m barrels a day, effective from the beginning of January, for six months. It may renew the agreement at the end of May.

Will it be sufficient to raise oil prices? The euphoria in the days after the meeting suggests bulls are ready to bite. But these are not the shock-and-awe cuts of 2008, the last time Opec cut. They are designed to give prices a perch and keep Opec-member economies from wilting-not set up another production bonanza. And the success of the cuts in achieving even these modest aims will depend on factors-from the US upstream to emerging-market consumers-that are beyond Riyadh's control.

For all that, it's a serious deal. Excluding Indonesia-which has suspended its membership (again)-and assuming output from Libya and Nigeria remains roughly at October's levels, Opec's total production will fall to 31.96m b/d. In October, used as the baseline for some but not all the members, output was 33.643m b/d.

Saudi Arabia's output will drop by 486,000 b/d to 10.058m. Iraq, the UAE and Kuwait share most of the rest of the burden. The numbers are significant-and not just for the volumes they entail. That Opec published them at all is important and adds weight to the deal. Gone are the days of hazy group-wide ceiling targets without individual limits. Under pressure from Russia, which says it will cut 300,000 b/d of its own supply too, Opec came up with real quotes for each member.

Announcing the news in Vienna on 30 November, Mohammed bin Saleh al-Sada, Qatar's energy minister and president of Opec, said the deal was "subject to" non-Opec countries agreeing to cut by 0.6m b/d. "We have non-Opec almost committed," he said. Within hours, Russia's energy minister Alexander Novak-with whom Saudi counterpart Khalid al-Falih shared a phone conversation in the middle of the Opec meeting-had announced that his country would remove its 300,000 b/d in the first half of 2017.

That was crucial. Saudi Arabia, the decisive actor in the Opec agreement, was not willing to proceed unless Russia was on board too. That condition will worry some in the market. Moscow now has the oil price in its hands. If it reneges on its commitment-as it did following a similar pledge in 2008-Opec's commitment will fray.

But that won't be known for months and, starting in January, real barrels will be removed from the market. The news will bring relief across the oil world, from Calgary to Aberdeen. Producers in the Permian can fire up the rigs. The about-face from Opec ends the free-market experiment begun two years ago. Today's decision might not end the price depression, but it signals a turn.

As news of the cuts leaked into the crowd of analysts and journalists awaiting the official decision in Vienna on 30 November, oil prices rallied hard. Before the meeting, most market observers had discounted any agreement at all, and few had predicted the size of the agreement. ( Petroleum Economist did.)

Brent leapt above $50 a barrel. News-wire headlines on the eve of the meeting had been relentlessly bearish, misleading some traders into short positions. By 2 October, $55/b Brent looked in sight. Saudi Arabia is understood to want a price of around that level, and not higher than $60/b.

For careful Opec watchers, a break-through had been on the cards since the Algiers meeting of 29 September, and the Vienna deal largely follows the one outlined then.

Crucially, the thorny internal disputes around Iranian production and Iraqi data have now been fixed. That, like the publication of the numbers, is significant too. It means a future Opec deal will not bring the same kind of blood-letting and tortuous diplomacy that this one involved.

Iran's output quota will be set at 3.797m b/d from January, a small vindication of its ambitions-but a source of confusion to some in the market. In fact, the logic is straightforward and the numbers are not wrong, as some commentators claimed. It is, though, a classic Opec fudge. Iran's new quota represents a nominal "cut" from Iran's baseline of 3.975m b/d-a number it insisted on in the meeting and which is based on what Tehran claims as its true pre-sanctions level. But Opec pegged its October output, based on secondary sources, at 3.69m b/d: the new quota allows it to increase supply.

This was important for Iran's domestic audience, because the producer has won both acknowledgement of its claimed output and the right to add more. Saudi Arabia conceded this point and efforts were made to ensure Iran did not display its triumphalism. Oil minister Bijan Namdar Zanganeh was a picture of calm and diplomacy after the meeting, even if the Iranian press were left to proclaim victory over the foe across the Gulf.

Petrodiplomacy

The concession from Saudi Arabia was the outcome of several months of diplomacy. Mohammad Barkindo, Opec's secretary general, and Algeria's energy minister Noureddine Bouterfa, were the orchestrators-in-chief, carrying messages between Russia, Saudi Arabia and Iran. Vladimir Putin, in conversation with Iran's President Hassan Rouhani in the days before the meeting, also pushed Tehran to give ground.

Russia's own terms were made clear in a briefing from Novak and Saudi oil minister Falih in Algiers on 29 September. There, Novak insisted Russia would wait for Opec to resolve its internal disputes-chiefly that between Iran and Saudi Arabia-before agreeing to anything. It was only when Opec had agreed internally that Falih stepped away from the horse-shoe table in Vienna's Helferstorferstrasse headquarters to call Novak and get Russia's final agreement.

None of this would have been feasible, though, without Saudi Arabia's change of strategy this year. It was visible in private briefings at the Opec meeting in June, confirmed in Algiers, and finally bore fruit in Vienna. Weak oil prices have hurt the kingdom and it has tired of the pain. The economic reforms proposed by deputy crown prince Mohammed bin Salman will be easier to achieve with more oil revenue. A stronger market will also help Aramco's valuation ahead of an IPO planned for 2018.

But Saudi Arabia's barely hidden wish for a deal in recent months made the process of getting one harder. Its rivals in Opec, Iran and Iraq, were emboldened, knowing Riyadh would need their acquiescence. Both countries pressed their claims hard-but only Iran won.

The country's output surge and wish to keep lifting production were accepted by Saudi Arabia as a price for the deal. And, with that out of the way, only Iraq was the true obstacle on the day. Its oil minister, Jabbar al-Luaibi, arrived in Vienna ready to cut-but only from the volume Iraq claimed it was producing, not from the (lower) secondary-source baseline used by Opec. But as it became clear on 30 November that this was Opec's last major obstacle to a deal, Luaibi caved. He phoned his prime minister, Haider al-Abadi, from the meeting room itself to get advice. Iraq conceded, accepting not just Opec's secondary source methodology but cuts of 210,000 b/d, a proportional decrease in line with the other Gulf Arab countries. It means Iraq, after decades of exemption, is now back within Opec's quota system.

Indonesia was a sacrificial lamb. As a net oil importer, its re-activated membership at the end of 2015 was baffling enough. The folly was plain as the rest of the group unanimously made a deal that would increase Indonesia's import bill. The country was handed a loaded pistol and withdrew from the table. The agreement takes account of Indonesia's departure-removing its 0.722m b/d of production from the ledger is not part of the cuts.

Will it work?

The deal will come under strain almost immediately as the market turns its eyes to Russia. Opec's "condition", that Russia now commit to cuts of 300,000 b/d (as part of broader non-Opec contributions of 0.6m b/d), is a shaky platform. Russia offered a similar commitment of restraint in 2008, only to wait for Opec to cut before it increased its own output. Oman, Kazakhstan and Azerbaijan are also expected to commit some cuts. But if they follow the 4.5% reductions applied by Saudi Arabia, their contribution will amount to only around 160,000 b/d between them. If they trim as Russia intends to, by 3%, they will remove just 100,000 b/d. Either way, with Russia's 300,000 b/d, non-Opec's cuts do not reach 0.6m b/d.

A meeting to iron out the terms of non-Opec's engagement was expected to be held in either Doha or Moscow as Petroleum Economist went to press. But it is plausible that Russia could reduce production during the winter while still exporting the same volume-or more-of crude oil and refined products. State company Rosneft, and its boss Igor Sechin, have hardly been warm to the idea of trimming output. A fight will ensue in Russia's oil sector to find out which producers will shoulder the burden of any cuts.

Still, Vladimir Putin's imprimatur is on this deal with Opec. Delivering real cuts that the market believes in will show just how tight his control of Russia's oil sector is. Sada pointedly said that Russia had asked that its commitment to cut be announced alongside Opec's own. The choreography in this meeting was important to all parties.

The agreement's efficacy-both Opec's own adherence and non-Opec's-will only be visible in shipping data later in the first quarter of 2017. That may be enough to get the market through some seasonal weakness before stocks begin retreating anyway.

That presumes demand will hold up despite any price surge. The reaction of Chinese imports for stock building to any Opec-induced market rally, for example, is not predictable. A rate rise from the US Federal Reserve, (expected at a policy meeting on 13-14 December, as we went to press), would strengthen the dollar and could damage emerging-market economies, oil demand, and dollar-priced crude.

The reaction of drillers in the US tight oil sector will also be a focus of the market in the coming weeks, especially if Donald Trump comes good on promises to rip up red tape in the sector. Any rise in rig counts will inject weakness into a rally this winter.

Indeed, Sada talked of Opec hoping to "catalyse the supply-demand balance to help the industry to revive and come back in production capacity to secure mid-term and long-term security of supply". Opec must hope this doesn't spark a price-killing surge in Texan output.

And the group's cut-exempted members, Libya and Nigeria, could yet prove just as significant to this effort to raise prices. Between them, and with a hefty dose of political stability, they could add 0.6m b/d in the coming months, taking much of the sting from Opec's wider reduction.

Saudi Arabia has done its bit to help end the slump. Opec has rediscovered its reason to be. The group's spectre now hangs over the market again. It is a seismic moment for the oil industry. But a sustained rally will now depend on others, from Texas to Tripoli, the Fed to Trump.

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