Opec’s cut: less than meets the eye

published 7 October 2016

Those who believe that Opec, the oil producers' cartel, can no longer move markets the way it used to had a surprise last week, says The Economist. Prices bounced by 5% on the news that Opec had agreed to cut output for the first time since 2008.

It has been pumping at full throttle in a bid to put US shale producers out of business and defend market share. But this has proved expensive, especially for swing producer Saudi Arabia, which racked up a budget deficit of 15% of GDP last year and has had to borrow money for the first time in years. It has even had to reduce civil servants' privileges and trim ministerial pay. So Opec is now willing to contemplate taking its foot off the accelerator. The idea is to limit production to 32.5 million to 33 million barrels per day (mbpd), between 0.7% and 2.2% below current output. The details are to be hammered out in November.

According to Goldman Sachs, if the cut is fully implemented, oil prices would jump by $7-$10 a barrel. But "this could turn out to be a head-fake by a still-dysfunctional cartel", says Robin Wigglesworth in the Financial Times. The key issue is the ongoing tension and mistrust between Saudi Arabia and Iran. Iran is determined to regain market share after being frozen out by years of sanctions, and may not be adequately placated by Saudi's offer of a cut in return for Iran freezing output at current levels, notes Fidelity's Tom Stevenson in The Sunday Telegraph. Opec is also notoriously ineffective when it comes to policing production quotas. What's more, non-Opec producers are ramping up production.

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Russia, for instance, is desperate for cash, and is likely to hit record production this month. US shale producers have become far more cost-effective in recent years, allowing more to operate at lower prices. This "ultimately puts a ceiling on the oil price", says Stevenson. "Only foolhardy bulls," says Wigglesworth, "will bet on a durable oil-price upswing."