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Opec tells the market: we’re back

Saudi Arabia has accepted Iran’s terms for a deal. Now Russia has to keep its pledge to cut too

Houston (and other parched oil patches), we have a deal.

Two months after setting the ball rolling in Algiers and eight years after it last cut output, Opec agreed here in Vienna to resume its efforts to prop up oil prices. The group announced cuts of 1.166m barrels a day, effective from the beginning of January, for six months. The deal may be renewed at the end of May.

Excluding Indonesia 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.

Announcing the news, 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. He dodged a question asking what would happen if those cuts didn’t transpire, and insisted Russia had pledged “at least” 300,000 b/d. “We have non-Opec almost committed,” he said.

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. Alexander Novak, its energy minister, welcomed the agreement and said Russia would cut its 300,000 b/d gradually, over the first half of 2017. But Moscow now has the oil price in its hands.

Whatever the doubts, real barrels will be removed from the market from January, insists Opec. 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 sank in, 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 was up by more than 7% by 1800 GMT to crest $50 a barrel. News-wire headlines on the eve of the meeting had been relentlessly bearish, misleading some traders into short positions.

But a breakthrough had been on the cards since 29 September, and the deal largely follows the one outlined then, in Algiers.

Iran’s output quota will be set at 3.797m b/d from January, a small vindication of its ambitions. This represents a nominal “cut” from Iran’s baseline of 3.975m b/d – a number it insisted on in the meeting. But Opec pegged its October output, based on secondary sources, at 3.69m b/d. So Iran has won both acknowledgement of its claimed output (important domestically) and the right to add more.

The agreement on 30 November is 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.

Russia’s terms were made clear in a briefing from Novak and Saudi oil minister Khalid al-Falih in Algiers. There, Novak insisted Russia would wait for Opec to resolve its internal disputes – chiefly that between Iran and Saudi Arabia – before agreeing to anything.

But Saudi Arabia’s change of strategy – visible since June, confirmed in Algiers, and enacted in Vienna – is the key. 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.

Will it work?

Riyadh’s wish for a deal handed an advantage to its rivals in Opec. Iran and Iraq both pressed their position hard – Iran won, but Iraq did not.

Iran’s output surge and target of lifting production to pre-sanctions levels have been accepted. But Iraq’s effort to have its claimed output numbers recognised instead of (lower) secondary-source ones failed. More than that, it accepted cuts of 210,000 b/d. Its decades of exemption from Opec cuts are over.

The market will watch Iraq carefully for compliance – oil minister Jabbar al-Luaibi only accepted the terms after calling prime minister Haider al-Abadi during the meeting. The cuts will most likely come from state-controlled fields in the centre of the country, not the south.

Indonesia was a sacrificial lamb of the Opec deal. 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 agreement takes account of Indonesia’s departure – removing its 0.722m b/d of production from the ledger is not part of the cuts.

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. It is not clear, either, from what baseline Russia intends to cut.

It is also 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.

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 efficacy of the agreement – 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 now. 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, possible within weeks, would strengthen the dollar and could damage emerging-market economies, their 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.

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 Libya and Nigeria could yet prove just as significant. Their exemptions from the cuts could allow for combined supply increases of 0.6m b/d, taking much of the sting from Opec’s wider reduction.

In short, Saudi Arabia has done its bit to help end the slump. But a sustained rally will now depend on others, from Texas to Tripoli, the Fed to Trump.

Opec's return? ('000 b/d)

  October 2016 production levels, 30 Nov (figures in brackets are figures reported by Opec on 11 Nov) Production level effective January 2017
Algeria 1,089 (1,088) 1,039
Angola 1,751* (1,586) 1,673
Ecuador 548 (549) 522
Gabon 202 (202) 193
Indonesia    
Iran 3,975 (3,690) 3,797
Iraq 4,561 (4,561) 4,351
Kuwait 2,838 (2,838) 2,707
Libya    
Nigeria    
Qatar 648 (646) 618
Saudi Arabia 10,544 (10,532) 10,058
UAE 3,013 (3,007) 2,874
Venezuela 2,067 (2,067) 1,972
Total 31,236 (30,766) 29,804

* September 2016 figures used

In October, Opec assessed Libya's production at 0.528m b/d, Nigeria's at 1.628m b/d, and Indonesia's at 0.722m b/d. Total output was 33.643m b/d

Source: Opec

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