by Matthew vonAllmen
This Wednesday, the Organization of Petroleum Exporting Countries (OPEC) agreed to restrict oil production for the first time since 2008. The announcement follows two months’ intense negotiations between the oil ministers of Saudi Arabia and Iran. The cartel has committed to reducing each member’s oil output by 4.6 percent, though Iran was allowed a minor exception to cope with recent sanctions. For Saudi Arabia, this means a decrease of 486,000 barrels per day. In addition, several non-OPEC countries have agreed to restrict output—their total cuts amount to 600,000 barrels per day. Russia accounts for half of this latter group’s cuts, making its cooperation vital to the cartel’s success.
Unfortunately for OPEC, monitoring Russia will be difficult. Most participating countries transport their oil by tanker, allowing the cartel to verify whether the agreed restrictions are unanimously observed. The majority of Russia’s oil, however, is transported by pipeline. This makes OPEC’s task far harder, and it remains to be seen whether Russia will follow through on its promises.
Higher oil prices may have several effects. Many predict a resurgence in US shale production, while others wonder about possible responses from the President-elect. The cuts are to occur between January and June of 2017. Since Donald Trump takes office on January 20th, this may be his first foreign policy challenge.
Prior to the agreement, analysts posited a 30 percent chance of renewed output restrictions. Oil futures reflected this view. During the two months of negotiations, the prices of crude oil futures for the first six months of 2017 gradually fell—traders predicted that OPEC’s oil ministers would be unable to reach a compromise. Then, on the day of the announcement, futures prices skyrocketed back to their levels from early October. For some of the six affected months, volume rose to twice its pre-announcement level as traders frantically bid up the price.
At first glance, this indicates that the OPEC agreement will have a massive impact on oil prices. Volume spikes of this magnitude around specific contracts are exciting, dramatic, and just rare enough to make headlines. However, a little context renders the cartel’s actions far less interesting. Since mid-2014, the oil futures in question have sunk to less than half of their original value. This recent price uptick doesn’t recover a fraction of that lost ground; the plummeting oil prices of the last few years were a far more powerful force than anything OPEC could exert.
Additionally, crude oil futures for the latter half of 2017 experienced similar price jumps. Either OPEC’s agreement is active for more than the specified six months, or much of the price changes are mere noise. It’s worth waiting for futures to settle before making any concrete judgments. While financial instruments are a useful way to forecast future events, they are certainly not perfect. Donald Trump’s election caused Dow futures to crash by 900 points—within a day they’d soared to new levels. Some circumspection seems in order.
From a historical standpoint, OPEC’s latest output restrictions are indeed noteworthy. Nothing like this has happened for nearly a decade, and it may not happen again for some time. However, their economic impact will likely be dwarfed by that of the myriad other oil supply shocks which have occurred in recent years.
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