Oil prices jumped following the news of the output reduction. The next day (December 1, 2016), Brent crude oil futures jumped nearly 9% to $50.47 a barrel following the news. By the middle of December, the price had reached more than $55 per barrel, and has remained around that level to date. This is nearly 25% higher than the average for the year, but still well below the 2014-2016 average price of $66.24.
OPEC’s agreement follows nearly two years of sub-$70 per barrel prices, with Brent crude oil futures ending as low as $28 in early 2016. The drastic fall in prices from more than $100 per barrel before 2014 to $44 in 2016 had a number of causes, including lower global demand due to slowing economic growth in key markets and technological innovations in the United States that led to American oil flooding the market, with a more than 7% increase in crude oil production between 2014 and 2015.
The persistence of low oil prices wreaked havoc on the public finances of oil-producing nations, many of which rely on the industry as the main source of government revenue. Saudi Arabia, the world’s largest producer, faced a nearly $100 billion budget deficit in 2015 and was forced to announce cuts to the generous subsidies and social welfare programs that allowed the Kingdom to emerge largely unscathed from the Arab Spring. Nigeria, the largest oil producer in Africa, is believed to have been struck by a recession after annual GDP growth of nearly 7% for a decade. And the economy of Russia, a non-OPEC member but still one of the top oil exporters in the world, contracted nearly 4% in 2015, and is still in the midst of economic crisis.
OPEC members and other oil-producing states hope that cutting production by a combined 1.75 million barrels per day will lead to higher oil prices. If the world’s oil-producers can limit output, then those producers can sell that scarcer oil at above-market prices and begin repairing their damaged public finances. This cartel behavior is one of the main functions of OPEC, whose mission statement says that part of its purpose is to secure “a steady income to producers and a fair return on capital for those investing in the petroleum industry.”
But there are several reasons to doubt that the November announcement will lead to sustained increases in the price of oil or to the economic recovery of countries that rely heavily on the industry.
Research on this topic generally finds that OPEC is a paper tiger at best, with no consistent power to influence the price of oil
The first reason has to do with OPEC’s ability to actually implement the promised cuts in output. Where a group of producers volunteers to limit overall production in order to raise prices and increase their revenues, any individual producer could undercut the other nations in the agreement by exceeding their production quota, earning even higher revenues and increasing their market share — provided, of course, that all other members keep adhering to their quotas. Cheating on production quotas is even more difficult to control if there are several members of the group attempting to produce more than their previously-agreed limit, and if there is no binding enforcement mechanism—both characteristics of the current agreement between OPEC members and non-OPEC oil-producers. While so far there seems to be a 91% compliance rate with the targeted cuts among OPEC members, which are part of the deal, there are already fears that the possibility of production rapidly coming back online in two states that were granted exemptions from the agreement — Libya and Nigeria — might “sabotage” the accord.
Indeed, this problem of overproduction has plagued OPEC for most of its history, ever since the oil embargo of the US in the early 1970s. Research on this topic generally finds that OPEC is a paper tiger at best, with no consistent power to influence the price of oil. One 2012 study by economists Vincent Brémond, Emmanuel Hache, and Valérie Mignon found that, for the majority of the time following the 1970s, the production decisions of OPEC had no evident impact on oil prices.
A second related reason to doubt the impact of OPEC’s decision is the shrinking role that the organization plays in global oil production. In 2005, OPEC members produced about 30 million barrels a day, on average, representing 38.5% of total output. In 2015, average output by OPEC members had increased to about 32 million barrels a day, but OPEC’s share of total output had shrunk to 36.5%. So even if OPEC members stick to their agreed-upon quotas, they constitute a smaller share of global production and their influence in the market is limited compared to a decade ago. This is why the involvement of non-OPEC members is crucial for the success of the plan.
One of the fastest-growing sources of added output during the last decade was the US, where technological advances in horizontal drilling and hydraulic fracturing (fracking) made once-inaccessible sources of oil and natural gas not only exploitable, but economically feasible. American oil and gas production increased by more than 50% over five years, from 371 million metric tons in 2010 to 564 million in 2015. And while US oil output decreased following the collapse in prices, the industry proved to be viable at a much lower oil price than previously thought. Therefore, even if OPEC and non-OPEC producers manage to stick to their quotas and prices begin to increase, eventually they could reach a level at which it is economical for US producers to come back online and begin grabbing market share, forcing prices to fall or at least stabilize in the long run — precisely the opposite of what OPEC intended in its November agreement.
