OPECs agreement to increase oil production by reducing over-compliance with 2017 deal is a drop in the barrel

economics

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An agreement on Friday June 22nd caused oil prices to increase by the largest one-day jump since OPEC agreed to reduce output at the start of 2017. At the beginning of 2017 OPEC and 10 other...

An agreement on Friday June 22nd caused oil prices to increase by the largest one-day jump since OPEC agreed to reduce output at the start of 2017. At the beginning of 2017 OPEC and 10 other oil-producing countries agreed to reduce their combined output by 1.8 million barrels a day, roughly 2% of global output. The 2017 deal was a reaction to the massive over-supply that brought prices down significantly since late 2014 when Saudi Arabia led the Organization of the Petroleum Exporting Countries to allow market prices to dictate their output. While the 2017 deal called for a reduction of only 1.8 million barrels a day, many countries reduced output even further resulting in 150% compliance of the planned quotas, or nearly 3 million fewer barrels of oil a day. Some members of OPEC had faced unexpected production outages whereas others simply chose to withhold their stockpile but the result was the same: oil prices were rising and global stockpiles were being used up to avoid a dangerous price spike.

The new agreement, taking effect in early July, aims to reign in the over-compliance of the 2017 deal and add more barrels of oil to the global market by returning to 100% compliance. To go from 150% compliance to 100% compliance, roughly 1 million barrels a day of crude oil would be added to the global market. However, some producers may be unable to increase their output for various reasons resulting in an expected increase of only 600,000 barrels a day. Russian Energy Minister Alexander Novak claims the $80 a barrel threshold hit in May of 2018 reflects the global inventory of surplus crude oil being reduced to a point where the oil market can rebalance itself. Saudi Arabia's Oil minister Khalid al-Falih promises his country will increase oil sales gradually starting in July. Iranian Oil Minister Bijan Zanganeh had reservations about any deal because economic sanctions from the US put them in a position whereby the increased output of others may take over Iran’s market share. Oil producing countries have to weigh the risk that big consumers may invest in renewables as well as produce their own oil, when available, if prices rise too quickly.

Leading up to this decision, the price of oil steadily fell from the $80 tipping point in late May with the expectation that OPEC and affiliated oil-producing countries would flood the
market similar to the 2014 decision. While supply will increase due to this new deal it is a far cry from the amount many investors had feared - and consumers had hoped for - therefore the price of crude saw a 3% increase due to the news instead of decreasing further. The month-long anticipation of increased supply lowered the price of crude oil but the end-result of the deal caused a market correction as speculation was replaced by the true figure. While the agreed-upon figure is an additional 1 million barrels a day, the expectation is that only 600,000 barrels will be added a day however some countries wish to produce an even greater amount of oil to take advantage of the high prices while they last. Such an over-correction could still happen in the coming weeks leading to a drop in oil prices but investors believe their fears of another 2014 crash is averted.

Without this boost to supply, OPEC feared prices could spike to surpass $100 a barrel which would drastically reduce global demand and severely cut into the profit of oil-producing
countries who rely on the revenue from companies exporting oil. Many worried the supply increase would cause American oil prices to drop below $30 a barrel again, which caused
massive unemployment in the industry and a huge loss of revenue. From 2014 to 2016, as much as $4 billion in American employee wages was lost in the oil industry.

Countries like Saudi Arabia and Russia have the ability to produce oil at a far lower opportunity cost than most other countries, giving them a comparative advantage in the global oil
market. During the 2014-2016 period of oil surplus that brought US prices below $30 a barrel, American producers had to develop the technology to continue production despite the nearly 200,000 oil workers who lost their jobs in the shale industry. US producers made good on that pressure and were able to maintain production gains through more efficient extraction and refining methods. The relatively loose regulations on hydraulic fracturing, or fracking, provided a much needed advantage to US producers who were able to leverage that technology and avoid Saudi Arabia's attempt in 2014 to shut small firms out of the market.

Avoiding a spike in oil prices in excess of $100 a barrel is beneficial to producers and consumers as demand would quickly plummet despite the short-term gains by companies such as Exxon Mobil Corp. and Chevron Corp as well as countries such as Russia hoping to capitalize on the high prices. Spikes in oil prices turn consumers away from their unhealthy dependence on oil in favor of renewables and alternatives to plastics; invites pressure from big consumers such as the United States who aren’t afraid of imposing reactionary economic sanctions; and benefits countries such as Russia whose major exports are oil. Massive increases in supply have the effect of hurting the governments who rely heavily on high oil prices to make their profit as well as hurting the small oil producers that struggle to produce efficiently when oil prices drop. With oil prices rising by over 40% since early 2017 due to geopolitical risks to supply causing unexpected shortages and the increasing demand matching increased economic growth, the global oil supply needed a moderate boost.

The United States exported a record high of 3 million barrels a day during the week of the Friday June 22nd deal - producing 10.9 million barrels a day. Progressing from exporting no oil to exporting more oil than all but three OPEC countries pump out of the earth is not solely the result of US efficiency - some analysts say a portion of the record-breaking exports was sourced from US stockpiles. Maintaining this level of oil exporting is not only unsustainable, it is hitting US consumers in the wallet at a time where oil prices are on the risk of surging to a new high for 2018 - perhaps even surpassing the triple digits per barrel. This may be viewed as the United States attempting to force smaller members of OPEC and most non-OPEC producers out of the world market for oil as this export record comes at a time when most countries have finally expended the last dregs of their stockpiles. Countries that can afford to increase output considerably include the United States, Russia, and Saudi Arabia - and the former two appear very eager to commit to flooding the market without a care for the resulting over-corrections of the market which would send the pendulum of oil prices swinging back and forth causing international uncertainty especially for countries heavily dependent on the oil industry.