Conditions for Success

OPEC's agreement in Algeria. Will oil prices recover?

02 October 2016


Global oil market breathed a sigh of relief on 28 September, as the price of oil rose by about 6 per cent, approaching $50 per barrel. Several global financial institutions, like Goldman Sachs, predicted that this price would increase from seven to ten USD in the first half of next year. The main reason behind these significant developments is the success of the ministerial meeting of the Organization of Petroleum Exporting Countries (OPEC) in Algeria, to reach a sudden and unexpected historical agreement to cut production to a range of 32.5 to 33 million barrels per day.

The agreement, ratified by the fourteen members of the OPEC, is considered the first cut off oil production since 2008; opening the door of hope towards the recovery of world oil prices after constant decline since June 2014 when it was hovering around $115 per barrel.

Relevant Results

The OPEC ministerial meeting in Algeria agreed to establish a high-level committee, comprising of representatives from member states, with the support of the OPEC Secretariat, to observe the level of production of countries and develop recommendations and mechanisms to implement the agreement. Moreover, the committee will undertake high-level consultations between oil producing countries that are member states of OPEC and those who are not, including risk identification and taking proactive measures that will ensure that the oil market is balanced on a sustainable basis.

During the last couple of years, the global oil market has witnessed many challenges that arose mainly from the vast surplus and surge in oil supply, and hence prices fell to more than half of their value, increasing instability and worsening price fluctuations in the market.

In this context, a report by OPEC, at the end of the extraordinary meeting in Algeria, referred to a significant decline in the oil revenues of producing countries and international companies, placing immense pressures on the financial status of producing countries and corporations, which in turn hinder their economic growth. The report noted that oil industry faced significant and widespread cuts in investment, causing layoffs and warnings of significant potential risks that oil supply may not meet demand in future, which will lead to adverse effects on the security of supplies to many countries.

The OPEC ministerial conference also concluded that there was a solid and shared ground supporting the ongoing cooperation between producers inside and outside OPEC, which would help in restoring the balance and sustainable growth in the market. It stressed that OPEC is committed to achieving the common interests of both the producers and consumers, by securing supply for consumers with acquiring decent returns on invested capital for all manufacturers.

While the conference noted that global demand for oil remains high, the supply outlook in the future takes a negative trajectory due to the substantial cuts in investments and massive layoffs, reflecting the broad challenges facing the market in the next stage.

Difficult Challenges

The primary objective of the OPEC meeting in Algeria, as stated by the Algerian Energy Minister Noureddine Boutarfa, is to stabilize oil prices. Having this meeting is important, especially because if world oil production pursues in its current trend, prices will stay at low levels until 2018, which will reflect negatively on investments in the oil sector, the economies of producing countries in particular, and the world economy in general. The Algerian minister said that "the price of a barrel of oil between $50 and $60 would be fair, and would contribute to the stability of the economies of crude oil producing countries".

Although the agreement in Algeria, and the subsequent developments in the global market for oil, demonstrates that OPEC is still an influential player in the market, it seems that the road is still long and hard before member states can implement  this agreement into action within the next two months, until the next OPEC meeting in Vienna on November 30, 2016. Several questions still need to be addressed, for example: which countries will cut production? And by how much? There is no doubt that determining individual quotas for OPEC members would be difficult under the economic strains plaguing most of the member states.

Another challenge facing OPEC is to identify the implementation and monitoring mechanism. Here a question arises: will production data be accepted from independent secondary parties or the official national data generated by each member state? Another issue that needs addressing: when would member states implement the cuts effectively on the ground? And when will the world feel the repercussions of this?  Member states are not expected to start implementing the agreement made in Algeria before 30 November if OPEC countries manage to address the previously reported issues regarding quotas and implementation mechanisms. Consequently, the impacts of the cut will not affect the global oil market, probably, before the beginning of next year.

Conditional Success

Doubts, concerns, and questions that revolve around the possibility of OPEC's success in implementing the Algeria Agreement in the coming days, does not diminish the achievement reached by its members, which agreed to the first production cut since 2008. Success in Algeria reflects the sense of danger felt on the part of the producers, and everyone's desire to cooperate to restore stability in the market and raise the price level in a way that supports the economies of producing countries.

This important development was not possible without a "strategic shift” in the position of Saudi Arabia, the biggest oil producer within OPEC. Saudi Energy Minister, Khalid Al-Falih, said that OPEC should allow Iran, Nigeria, and Libya to produce reasonable maximum levels in the framework of any agreement on capping the production. These statements reflect a shift from Riyadh’s previous position, namely the need to maintain its leading market share at the expense of price recovery while obliging Iran to maintain its current levels at approximately 3.6 million barrels. This position is rejected by Tehran that has repeatedly asserted its right to return to production levels before international sanctions. This shift in the Saudi position may be attributed to the economic difficulties faced by Riyadh currently, especially as it posted a record deficit in its 2015 budget totaling $98 billion, pushing it to take austerity measures including pay cuts for government employee salaries.

Nevertheless, it can be noted that the Algeria Agreement announced by OPEC concerning the cutting of oil production to stem falling prices, reinforces the role of the organization on the global, political, and economic levels, particularly as it allows the organization to restore the monitoring function of the world oil market, a long-lost role. This agreement also reflects the tireless efforts of a large number of OPEC members to reach a consensus to ensure oil market stability in the future. However, one yet awaits to see a practical implementation of this agreement and greater transparency, rather than just “throwing dust” in the eyes of those who declared OPEC clinically dead.

In this context, the world will focus on future meetings of the organization, particularly the Vienna meeting on November 30, 2016. This session is supposed to determine the share of each member state in the cut and will clarify if there are any exceptions for individual countries. It is necessary to identify each state's share of OPEC production because uncertainty could lead to the return of another price decline and may reflect negatively on the climate of confidence in the market especially regarding serious cooperation between producers.

It will also be necessary for OPEC members, which produce only 40 per cent of global oil production, to collaborate with other oil-producing countries outside of OPEC, notably Russia, to join the agreement. The success of OPEC in Algeria will largely depend on the attitude of Russia during the next period. So far, Moscow's position seems unclear, where the Russian Energy Minister, Alexander Novak, said that his country would reveal its proposal to reduce oil output after OPEC's final decision, expected at the end of November.

What is encouraging in this respect is the growing likelihood of coordination between Moscow and Riyadh to cut or maintain production in the coming period, thereby stabilizing the world oil prices, especially after the two countries established a joint working committee to discuss ways of how they can mutually cooperate in this area. This group has started to work efficiently and scheduled a meeting during the first half of October.