Rising Oil Prices

December 5, 2016

 A surprise announcement this last week by OPEC to decrease oil production sent oil prices above $50/barrel. Its members have pledged to remove 1.2 million barrels per day from production with the caveat that they expect non-OPEC countries (primarily Russia) to also reduce production by an additional 600,000 barrels per day as well. This represents a 2% decrease in global supply and is anticipated to end the glut of oil we have seen over the last two years.


For most, the deal was surprising because of the players involved. For those who don’t know, OPEC stands for Organization of Petroleum Exporting Countries and its members make up nearly half of the world’s oil production. While they do work together, it brings together some natural rivals (most notably Iran and Saudi Arabia) who have been at odds over the last couple of years in regards to oil production. Iran has been hesitant to cut any production as they are working to recover from the economic sanctions imposed during the nuclear negotiations. Saudi Arabia, however, did not want to be the only country to decrease production and was insistent on cuts across the board.

 

A compromise was struck and Iran has been allowed to maintain current production levels as everyone else makes cuts. Russia has pledged to cut 300,000 barrels a day and the announcement is expected this week. The agreement runs through the first half of next year and is expected to bring some stability to oil prices for the near future. However, there is a limit to how high prices can rise as U.S. companies can ramp up production by their shale producers as prices increase. Another point of contention to keep an eye on will be accountability by the other countries to maintain their end of the agreement. It is already widely accepted that the OPEC members keep an eye on each other’s oil tankers to measure output but countries such as Russia mostly ship their oil by pipeline which can’t be monitored.

 

In the short term, this is supportive of oil companies and their stocks saw a sharp rise in price last week. The increase is small enough to not have a significant drag on consumers in the U.S. and, overall, is considered a positive move for the economy. Losers could be companies they have been taking advantage of low oil prices such as airlines as they scramble to hedge prices to cover tickets already sold.

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