Oil Rallies as OPEC Delivers on Production Cuts

Last week, the 14-nation OPEC members surprised by coming to a consensus of curbing oil production to rebalance the oil markets. In a surprise move, OPEC President, Dr. Mohammed Bin Saleh Al-Sada announced that oil production by OPEC nations would be capped at 32.5 million barrels, cutting about 1% from the current pace of production. It was more than what the markets had expected.

The news came amid rumors of no deal earlier in the week after Saudi Arabia sat of the sideline meetings noting that there was no consensus. However, by Wednesday evening, it was clear as news was leaked unofficially on the impending deal to cut oil production. It was for the first time in nearly 8 years that OPEC delivered its first production cuts with aims to reverse the slump in oil prices. Global oil production is expected to be down by 1.2 billion barrels a day effect January 2017.

Crude oil futures for January 2017 delivery jumped 9.3% on the day and extended the gains by another 4.06% on Thursday. WTI crude oil futures touched a two-month high at $51.80 a barrel before pulling back. Meanwhile Brent crude oil futures for February delivery rose to $54.28 just shy of the $54.58 all time high this year.


WTI Crude Oil Futures

As part of its production cuts, Saudi Arabia surprisingly agreed to cut nearly 4.5% of its output by around 500k barrels per day. OPEC also pushed the responsibility of production cuts to non-OPEC countries which are expected to scale back production by 600k barrels. Of this, Russia alone is expected to lower production by 300k barrels per day, a commitment Russia says it will adhere to.

Iran for its part agreed to put its production levels on freeze in what many see as compromise between Iran and Saudi Arabia. Nigeria and Libya were exempt from the production cuts.

OPEC deal still not very convincing

While oil prices have rallied on the OPEC deal, many experts say that it all comes down to implementation. OPEC also formed an oversight committee to ensure compliance to the production cuts.

But doubts still remain as OPEC does not officially have an impact on controlling how much its members produce. Furthermore, it is estimated that OPEC member countries cheated on production quotas 96% of the time since 1982 through 2009, according to a study conduction by Jeff Colgan, a Brown University professor.

“Even OPEC assumes cheating, which is why they established a compliance committee (although it’s toothless),” Colgan said.

OPEC leaders are expected to meet with their non-OPEC counterparts on December 9 in Doha to discuss further details.

Skeptics of the OPEC deal argue that back in 2014 when OPEC decided to open up production, the cartel was producing 30 million barrels per day. Since then, and after Iran’s sanctions were lifted, Saudi Arabia and Russia were seen ramping up production in a bid to get more market share.

The markets were inherently cheering the OPEC deal but many do not expect this last. Also with the increase in fracking many see this recent OPEC deal as a desperate attempt to regain its influence on the oil markets. The next general body OPEC meeting is scheduled for May 25th, 2017.