The Organization of the Petroleum Exporting Countries (Opec) has finally got a deal with its production target at 32.5 million barrels per day. Crude oil prices rallied. Brent crude price went up about 9% on Wednesday.
The bigger question of course is whether the strength in prices will persist. Consider the chart above. After Opec announced its intention at September-end to cut production, crude oil prices had rallied. But news reports on old disputes resurfacing among some Opec nations, highlighting the fragile nature of the organization’s agreements, weighed on prices after some time.
Sure, the fact that a deal is sealed is a positive development. It will help bring forward the rebalancing of oil markets. But having said that, it won’t be surprising if prices follow a similar trend yet again.
For one, the agreement is effective starting January. Secondly, as Madhavi Mehta of Kotak Commodities Services Ltd points out, the biggest challenge is whether Opec members will adhere to new production targets. Moreover, any incremental production from Libya and Nigeria, countries that have been exempt from making any adjustments, will delay the rebalancing of markets.
Opec says the duration of this agreement is six months, extendable for another six months to take into account prevailing market conditions and prospects.
Non-Opec supply is another area of concern. Key non-Opec countries are expected to reduce production too, by 600,000 barrels per day. Russia is expected to account for half of this cut. “Russia has in principle agreed to reduce output but is yet to finalize it,” says Mehta. News flow on non-Opec contribution in the deal will be important to follow in the days to come.
Last, but certainly not the least, higher crude oil prices should offer support to US shale oil producers. From a medium-term perspective, that’s not good news for prices.