FX: Opec finally reaches deal to cut oil production
After failing to reach agreement at its last two meetings, Opec agreed this week to cut oil output for the first time in eight years. The oil price responded favourably, but lingering doubts about the finer details could mean the impact is short lived.
Opec has agreed to cut production by roughly 1.2 million barrels per day, its first cut in eight years, setting a new ceiling at 32.5 million barrels per day.
Effective from January 1, the agreement applies for six months, at which point it will be reviewed, with the expectation it will be rolled over for another six months.
The reduction was welcomed by the market, after a period of considerable volatility that had caused some to question whether Opec was still relevant. The oil price had been rising in the hours before Opec's announcement, reflecting optimism that a positive outcome would be reached, and WTI crude touched $49 once the deal was confirmed.
Brent saw an 8% move on the day and continued rising on Thursday morning, trading above $52, while WTI was just under $50.
Brent had generally been performing strongly since September, when the organization announced it would cut its production to 32.5 million barrels per day. At that time the Opec Reference Basket stood at just above $42, rising to above $49 by mid-October. However, doubts that the cuts would be implemented saw prices start to fall again, and by November 14 the price was below $41.
James Hughes, chief market analyst at GKFX, says: “The swings in the markets on the back of every tweet that was sent by anyone close to the meeting showed the jitters and expectations that rested on Opec and any failure could well have sparked some heavy downside for not just oil prices but equity markets and the US dollar as well.”
Oil-producer currencies were moderately firmer in response, and the JPY was notably weaker.
The deal came with a significant caveat, in that it is contingent on non-Opec members slashing their production by 600,000 barrels per day.
Russia has committed to meeting half of that target, according to Mohammed Bin Saleh Al-Sada, Qatar's minister of energy and industry and president of the Opec conference. Other countries have also made commitments, he says, and he was confident the 600,000 target would be met or exceeded.
Having failed to reach agreements at its last meetings in February and September, it was seen as imperative for Opec's credibility that it reached an agreement on Wednesday.
One way it was able to do that was through Indonesia's suspension from membership of Opec, the country having been unable to commit to the production cut, given that it is a net oil importer. Opec said Indonesia’s share of the production cuts will be absorbed by Opec's other members.
GKFX's Hughes says: “Opec needed to show that they can bring their members together in order to affect the global market. If they had failed to agree it would call the whole purpose of the organization into question. So this is just as much a PR job for Opec as it is a move to push prices higher.”
David Cheetham, market analyst at online trading platform XTB, adds: “The issue is that all 12 members are in agreement that measures to curb production and support price would be beneficial. However, most would prefer other members to cut rather than themselves.”
Notes Sue Trinh, senior currency strategist at RBC Capital Markets: “Historically, Opec’s track record of enforcing production cuts has been poor."
To try to improve on this, Opec has created a monitoring committee, chaired by Kuwait and assisted by Venezuela and Algeria, that will ensure members comply with the reductions, reporting back to the secretariat.
In cutting output to levels seen in April, when Saudi Arabia ramped up production, Opec members were shouldering a proportion of cuts that is greater than their proportionate share of overall global production, notes Bin Saleh Al-Sada. This, he insisted, demonstrated the cartel's continued relevance.
However, Hamza Khan, head of commodities strategy at ING, says glaring errors to Iran's and Angola's numbers make Opec's commitment difficult to swallow, suggesting the countries are being given more leeway than official statements suggest.
He also queried how Russia's production cuts would be measured, and whether Russia would remain committed to scaling back its output after the repricing of oil.
It also remains to be seen how much influence Opec still has on the oil price given the rise of US production. Given the short-term rise in prices, “it seems Christmas has come early for US producers with this deal”, says Khan, suggesting US producers might be more than happy to make up the production shortfall.
It is therefore unclear whether the deal will be enough to reinvigorate the oil price beyond the short term.
Daniel Katzive, head of FX strategy for North America at BNP Paribas says: “Our commodity strategists do not expect this week’s jump in crude prices to be sustained, much less extended. They note that markets are likely to focus on implementation and compliance risks now and that the supply reduction will not be sufficient to address the global inventory overhang quickly.
"Moreover, at WTI levels near $50, expectations for increased – or less reduced – US supply are likely to offset the benefits of the deal to some extent.”
Others are more confident the effect on the oil price will be sustained. If it is, then Lee Hardman, currency analyst at Bank of Tokyo-Mitsubishi UFJ, reckons “one potential spill-over impact from the higher price of oil could be that it reinforces Trump reflation trades. Tighter supply combined with stronger demand if president Trump’s policies help to boost US and global growth would increase upside risks for inflation.
"The Fed is likely to be under even more pressure to speed up the pace of rate hikes in the coming years, supporting a stronger US dollar.”