On Wednesday September 28th, OPEC countries meeting in Algeria struck a deal to reduce worldwide oil production. According to most sources, this reduction is set to be in the range of 750,000-800,000 barrels less per day.
By John Vincent
The deal comes in the midst of a downturn in oil prices, with barrels having been valued at well under USD$50 for quite some time and with the prospect of reaching USD$70 levels nowhere near on the horizon.
This huge price drop from previous levels of USD$100 per barrel has really hit oil extraction firms outside of the OPEC countries hard since they have effectively been priced out of competition. The US shale industry, for example, has had an especially difficult time keeping up with its heavy oil counterparts in Saudi Arabia and Iraq.
The significance of this deal and its potential long-term ramifications should not be understated, and those following developments in the Middle East should hold an interest in this deal as well. Lowering production so significantly will in fact raise oil prices for the rest of us, which from a consumer perspective has its obvious short-term downsides. But for the oil industry as a whole this is excellent news. It means that the pricing out of Saudi and Iraqi oil competitors will be lessened, and in the medium-to-long run this could mean a lower equilibrium oil price in the future. OPEC countries are of course aware of this, and thus (one would imagine) they will view these long-term considerations with caution. Hopefully though, OPEC maintains a stance of keeping supply limited.
The headwinds to this deal however are the notable countries not included in the deal: Nigeria and Libya. However, these OPEC countries are far down the list when it comes to world oil production, so the bet is essentially that their unregulated production will not offset the planned barrel reduction.
A serious non-OPEC variable to consider is that of Russia. Russia does not seem poised to cap oil production any time soon because its oil industries are benefiting enormously from the low price of crude. Russian cost of oil production has been estimated according to some sources to be as low as USD$20, which can nearly rival Saudi costs of production. This could become a thorn in the side of OPEC efforts to lower global oil supply.
Another longer-term consideration is that Venezuela, whose geopolitical situation prevents it from being a major player alongside the other OPEC countries, has enormous proven oil reserves. In the long-term, however, the Venezuelan caveat could raise oil supply and lower prices in a major way if circumstances permit extraction of the country’s vast proven oil reserves.
One final point of interest from the OPEC deal was the rare agreement between Iran and Saudi Arabia. Iran ranks third in terms of oil production amongst OPEC countries (behind Iraq and Saudi Arabia), and so any major OPEC deal usually requires Iranian consent.
This is rarely achieved, especially on deals of this magnitude. Saudi Arabia and Iran are regional rivals: both have conflicting oil agendas and there are enormous cultural and religious feuds that exist between the two countries. The fact that they have successfully come to an agreement will hopefully lead to future cooperation between the two oil titans.
In the meantime, the effects of the OPEC deal should be felt in the coming months, and the market (which came in with very low expectations for the meeting) will have plenty of time to react to the agreement. One can only hope Mr. Market sees the deal for what it is and smiles at the long-term prospects.