Why oil-price rallies soon falter

published 18 August 2017

Opec, the oil exporters' cartel, has never been very good at sticking to deals to rein in output. They recently agreed to cut production to mop up a glut and shore up prices, but it turns out they aren't doing too well this time round either. According to the International Energy Agency, some producers are "showing signs of weakening their resolve".

In July, the compliance rate among Opec members was just 75%; overall production actually rose. Expect the cheating to continue, Tariq Zahir of Tyche Capital Advisors told Barron's.com. Some countries could even pull out of the deal altogether.

So what's the problem? Opec states have become more dependent on oil revenue this decade, as The Wall Street Journal points out. They used $100 oil to boost spending in order to "pacify restive populations during the Arab Spring" in 2011, and now they daren't cut state spending too much. They are tempted to cheat and go for jam today over jam tomorrow. This looks unsustainable in the long term, however. They now need oil to be higher to balance their budgets and this shift has coincided with the advent of US shale oil, which has become increasingly cost-efficient on the exploration front. Opec's market share has declined to 40% from 55% in the 1970s.

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US shale is coping with lower and lower prices, producing more oil and thus capping price rallies, just as Opec has begun to need the highest oil price of anyone in the market higher than Big Oil too. The US government estimates that American production will hit an all-time high in 2018, eclipsing 1970's figure. No wonder oil-price rallies never last very long.