By Krzysztof Głowacki, Economist, CASE
Last Saturday, the Organization of Petroleum Exporting Countries (OPEC), together with a number of other affiliated oil producers, signed a deal to reduce oil output starting from January 1st, 2017. The deal is the first global oil pact since 2001, and, if implemented, may bring a sustained increase in global oil prices.
At an earlier meeting in November, OPEC countries had agreed to reduce oil production by a total of 1.2 million barrels per day (bpd) starting on January 1st, 2017. The deal has now been extended to encompass a further reduction of 558,000 bpd, split amongst Russia (300,000 bpd), Mexico (100,000 bpd), Kazakhstan (50,000 bpd), and nine other countries. Both deals are supposed to put the brakes on oil overproduction, which saw the oil price plummet from $115 in mid-2014 to below $50 and even $30 in 2015. Following the announcement of the agreement, the price of Brent crude increased to its 16-month peak to almost $58, although it has since fallen below $54 as the dollar appreciated over the Fed’s interest rate increase. In any case, no oil shortage or dramatic price surges are expected, as oil production is set to remain at a high enough level to prevent such an eventuality.
Politically, the new deal strengthens Russia, whose economy and political system has relied on oil income since Putin’s rise to power in 2000, and which took a hard hit from the fall in global oil prices. Although its economy is still ailing, Moscow is now likely to be more forceful in its dealings with Europe. But there seems to be another winner: US shale oil producers. They, too, had been affected by the low price levels of the past two years, with many forced to close business. Now the deal comes as a positive externality for US producers, with the higher world price expected to increase output and boost profits while attracting new entrants and stimulating technological development. In this way, a portion of the gains from the deal will be captured by a non-OPEC member.
Of course, all of the above is subject to the agreement’s implementation. OPEC deals traditionally suffer from compliance problems, being a textbook example of how cartels fail over individual members’ incentive to cheat. Both OPEC and non‑OPEC parties have been notorious for their non‑compliance with output reduction agreements, and mutual mistrust among the parties was a major source of delay in the negotiations over the past months. It remains to be seen whether the current deal will elicit more compliance that the one fifteen years ago, which eventually collapsed.