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Saudi Arabia has lost the war of attrition in the oil market
Opec has finally come to an agreement to reduce production, sending the oil price soaring. John Stepek looks at why the market is so excited.
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On one side, we have Opec, the oil cartel dominated by Saudi Arabia.
On the other, we have the new kids on the block, the US shale oil producers.
Until now, Opec's avowed strategy has been to flood the market and put the shale producers out of business.
Put simply, that hasn't worked. So now they've changed tack
The end of the oil wars?
The big oil producers all sat in a room in Vienna yesterday, and came to an agreement to reduce oil production.
That's why the oil price shot up by around 9% yesterday, to end up back above $50 a barrel (as measured by Brent crude prices).
It's not been easy to get everyone to this point. Right up until the deal was announced, the market wasn't entirely convinced it would happen.
No one wants to sacrifice market share. That's one reason why oil production has continued to rise in recent years, despite the collapse in the price. Saudi Arabia - by far the biggest Opec producer - didn't want to cut back and allow other Opec members, or Russia, or US shale producers, to poach its customers.
On top of that, Opec members tend to be on the fractious side, politically speaking. Iran and Saudi Arabia in particular, don't like each other. In fact, they're fighting a bit of a proxy war with one another even as we speak. Not easy to agree a deal in those conditions, I'm guessing.
However, it looks as though Saudi Arabia has buckled. Iran has only recently been allowed back into the global oil market, due to the relaxing of sanctions on the country. So it hasn't had quite the same dependence on oil revenue that the Saudis have.
In Saudi Arabia, on the other hand, the tumbling oil price has forced the country to issue bonds, slash civil servant salaries, and generally tighten its belt (it was a very loose belt, let's be fair here). And now it's clearly had enough.
The oil cartel has now said that it will cut oil production by 1.2 million barrels of oil per day, to 32.5 million. That's the first cut in eight years. Of that, Saudi Arabia will be accounting for nearly 500,000 barrels. Iran meanwhile, will be allowed to raise its output to around 3.8 million barrels a day, in recognition of its need to recover from the sanctions.
On top of that, some of the most important non-Opec producers have agreed to cut production by 600,000 barrels a day.
Wow sounds big. The market apparently thought so. But as is customary with Opec deals, the devil is in the detail.
Dodgy maths and fickle partners
And even Saudi's big cut of 500,000 barrels will only take it back to the average levels of oil it was pumping in the first half of this year. And of course, Opec "has a terribly history of complying with its own quotas."
There are other aspects of the deal that aren't entirely clear. For example, Russia the main non-Opec player accounts for 300,000 barrels of the 600,000 planned cut by non-Opec producers. But we don't know if that's from current levels, or if it's simply 300,000 less than they had planned to pump in 2017.
Meanwhile, Indonesia left the cartel yesterday. It had rejoined as a member less than a year ago, but unlike the other Opec members Indonesia is a net importer of oil, consuming about twice as much as it produces. So it had no desire to cut its own production.
To cap it all, there were various typos in the production quota table handed out to journalists. Iran's figures didn't add up, for one.
So you have to wonder just how big this move really is.
I mean, sure, you can see why Opec wanted to announce a deal yesterday. It had to announce something. Any sign that the "pump and be damned" attitude was continuing could have seen the oil price collapse once again.
But why is the market so excited about it?
The real significance of this deal
That suggests that whatever else happens, the eyes of Opec are now firmly on the oil price, rather than market share. If this attempt at a deal doesn't work to prop up prices, they'll try harder next time.
That suggests that while the price might not be destined for $100 a barrel any time soon oil producers will be keen to defend current levels, at least.
Clearly that's good news for oil companies, and the FTSE 100 saw the benefit of that yesterday. And it's particularly good for Opec's arch-rivals the shale oil producers.
As Reuters points out, these companies are now incredibly efficient. That's the hard-won benefit of the squeeze on prices that they've endured. "In shale fields from Texas to North Dakota, production costs have roughly halved since 2014."
Apparently, in parts of North Dakota, it costs just $15 to get a barrel of oil out of the ground. That's about the same as Iran's cost of production.
Throw in transport costs and the like and they still won't make a profit at under $45 a barrel, but it's still pretty impressive, and it's only going to get better. I suspect that they'll be the main beneficiaries of Opec's efforts to prop up prices.
Of course, then there's the impact of oil prices on inflation. That could have a much more far-reaching effect but we'll talk more about that in the forecasts issue of MoneyWeek, out next Friday.
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