×

OPEC deal prevents big decline just when oil was about to tank

An agreement by OPEC to work toward a production cut could halt a bigger price decline and points to the strain low crude prices have had on producers, including the largest exporter, Saudi Arabia.

OPEC struggled to reach the deal, just as oil prices were set to head lower, due to reduced demand from the refining industry. Each year, during the switch over to winter fuel production, industry demand drops as refineries undergo maintenance. That is known as the "shoulder season," and the market had been bracing for another decline in prices during it.

OPEC's surprise ability to take action also helped boost the organization's relevance again, after it had been written off by many market players. Oil prices immediately surged more than 5 percent Wednesday after Reuters reported from Algeria that OPEC members agreed to cut output for the first time since 2008. West Texas Intermediate was trading at just about the same level Thursday, close to $47 per barrel. Without a deal, analysts had said oil could plunge to $40 or lower.

"I think the price will wobble, but it certainly keeps more support than walking away with nothing. What I think is this will be a process. This isn't even an official OPEC meeting, and it buys them time," said Daniel Yergin, Vice Chairman of IHS. "It's them negotiating to negotiate."

A gas flame is seen in the desert near the Khurais oilfield, near Riyadh, Saudi Arabia.
Ali Jarekji | Reuters
A gas flame is seen in the desert near the Khurais oilfield, near Riyadh, Saudi Arabia.

OPEC agreed to a modest cut of between 200,000 and 700,000 barrels a day from its current 33.2 million barrels a day. The Organization of Petroleum Exporting Countries would then wait until its Nov. 30 meeting to finalize a plan. A committee will decide which countries will cut and by how much. Some members of OPEC, like Libya, Nigeria and Iran have been trying to raise production, while struggling Venezuela and Algeria can't afford to cut.

The move is also an acknowledgement by Saudi Arabia that the cartel's policy of letting the market set the price was not enough to curb the global supply glut even if it did shake out some high priced producers, such as U.S. shale. The timing of the deal is interesting in that it comes at a tense time for U.S. and Saudi relations.

On Wednesday, Congress overwhelmingly voted to override President Obama's veto of the 9/11 bill and families of victims will now be able to sue Saudi Arabia. The country has warned that it would have to sell billions of dollars in U.S. assets to avoid them being seized by U.S. court settlements.

The OPEC deal also comes as Saudi Arabia is entering an important phase of its plan to remake the kingdom's economy into one that is more economically diversified and less dependent on oil. As part of that plan, Saudi Arabia is floating stock in its state-owned oil company, Saudi Aramco possibly next year. The kingdom is also expecting to float $15 billion in debt this fall.

"I think their mission number one is 'Vision 2030' and to implement that," and a stable oil prices helps, said Yergin, of the economic plan designed by Deputy Crown Prince Mohammed bin Salman. "Even though they want to move their economy away from oil, I think that there's such intense focus internally in Saudi Arabia right now ... While this is going on they're trying to reform. Reform usually comes when oil prices are low, not when they're high."

"They don't want to see prices down another $5 ... If they hadn't come out with something, that would have been the risk. The market would have really just swung down again. That's as expensive for them as for everybody else," Yergin said.

Goldman Sachs oil analysts said the agreement does not change their forecast of a year end price of $43 per barrel this quarter, down from their previous $50 forecast.

Barclays analysts called the agreement "another last ditch effort to kick the can further down the road and preclude market participants from positioning short during the coming shoulder season. This action will help OPEC keep those shorts on the sidelines until November, when winter-related demand will return and the prospect of market balancing is in further focus."

Even the suggestion of a deal means that Saudi Arabia and Iran have come to some terms that would constrain production. The long-time rivals have been at odds over whether Iran would freeze or cut production. Iran had strenuously resisted curbing production, since it has been trying to rebuild its market share now that sanctions against it have lifted.

"It matters because it signifies that despite the Saudi/Iranian geopolitical tension, oil policy was able to remain separate from the broader political issues, for now at least. The experience has uncanny similarities to the Saudi/Venezuela agreement of the late 1990s. In that case, Venezuela, like Saudi Arabia and Iran, was trying to attract investment," the Barclays analysts wrote. They also noted that the Iranian minister in charge in the 1990s is now the current Iranian oil minister, Bijan Zanganeh.

"OPEC may have been in hibernation for the past two years, but it is certainly not dead, nor should one assume that it cannot exert influence over a market, especially one where positioning has moved to extremes," Barclays analysts wrote.

Saudi Arabia has been pumping record amounts of oil, and if it cuts 400,000 barrels a day, as suggested in some reports, that would be the equivalent of what it might normally have cut back going into this time of year. Saudi was producing 10.7 million barrels a day in July and slightly less in August.

"What is important is this is incredible to get this done. Saudi Arabia really had to give ground," said Helima Croft, head of global commodities strategy at RBC. She said the credit goes to Saudi oil minister Khalid al-Falih, who replaced longtime oil minister Ali al-Naimi in the spring.

"We talked about Naimi being the maestro. This is Khalid al-Falih being the diplomat," she said. "This time, the Saudis basically got victory out of the jaws of defeat. Khalid al-Falih is single-handedly rescuing OPEC's relevance."

Croft said part of what probably pushed the deal was turmoil on the home front. Saudi Arabia cut the pay of civil servants by 20 percent this week.

"It looks like the Saudi stock market was just getting pounded on the news of no deal. You had quite a negative reaction on social media, in terms of what they did with the wages of civil servants and the reduction of benefits. This will go down well in Saudi Arabia. This will be greeted well. This will give a boost to the stock market. It will be good for overall sentiment. It wont be seen as giving ground to the Iranians," she said.