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Here’s Why Oil Prices Jumped 8% Yesterday

Thursday, December 1, 2016 5:41
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From Oil prices surged more than 8 percent on Wednesday as OPEC shocked the world and reached an agreement to cut production. If OPEC members succeed in implementing the deal, set to take effect in January, it could erase the global surplus in an instant.

“The sentiment generally is optimistic and positive,” Saudi Arabia’s Oil Minister Khalid al-Falih said before the final meeting on Wednesday. “Any production-restraint agreement has to be distributed in an equitable way. We are getting close.” Oil prices skyrocketed on his comments and on the news that a deal was within reach.

Still, there was a lot of confusion right down to the last minute, with some news outlets reporting a deal had been reached while others said that the details had not actually been agreed to, just the broader outline. Iraq in particular was a question mark, with reports saying that Iraqi officials were still disputing the “secondary sources” data well into the afternoon on Wednesday, even as oil prices were posting huge gains. Negotiations dragged on through the day, with only snippets of details emerging from reporters in Vienna.

In the end, OPEC agreed to cut its collective output down to 32.5 million barrels per day (mb/d), a cut of about 1.2 mb/d from October levels. But they leveraged those cuts to bring some key non-OPEC producers on board, including Russia, for an addition cut of about 600,000 barrels per day. Russia alone will cut 300,000 barrels per day. Asked about the non-OPEC contribution, OPEC President Mohammed Al-Sada said that he is confident that they “can get 600,000 barrels per day out of them…maybe more.”

The deal appears to be a remarkable compromise after months of an impasse between Saudi Arabia, Iraq and Iran. Saudi Arabia’s Khalid al-Falih said that his country was prepared to take on much of the burden in order to conclude the deal, but only if other countries offered something as well. “It will mean that we (Saudi) take a big cut and a big hit from our current production and from our forecast for 2017. So we will not do it unless we make sure that there is consensus and an agreement to meet all of the principles,” he said a few hours before the deal was announced.

Saudi Arabia will account for almost half of the agreed cuts, reducing output by nearly 0.5 mb/d, which will take overall production down close to 10.0 mb/d. Iran’s figures are a bit confusing, given that the numbers don’t add up on the agreement text that OPEC published. Iran wanted its output to climb to a pre-sanctions level of at least 4 mb/d, while Saudi Arabia insisted on a freeze at 3.7 mb/d. Algeria’s energy minister offered a middle ground – roughly 3.8 mb/d. Despite the discrepancy in the figures published by OPEC on Wednesday, it appears that Iran will be allowed to boost production by another 90,000 barrels per day to 3.8 mb/d, with both Iran and Saudi Arabia offering some concessions.

Clouding the specifics on Wednesday was the small matter of Indonesia suspending its membership in OPEC, due to its status as a net oil importer. It appears that Indonesia will not be part of the deal but its production volume of 722,000 barrels per day will be included in OPEC’s 32.5 mb/d target, which means its withdrawal will not affect the specifics of the agreement.

The six-month accord will need to be renewed at OPEC’s next official meeting in June, but by then the cartel could have done a great deal to zero out the supply surplus. The IEA estimated that global supplies exceeded demand by just 300,000 barrels per day in the third quarter, so a cut of 1.8 mb/d (1.2 mb/d from OPEC plus another 0.6 mb/d cuts from non-OPEC) will quickly tip the global balance into deficit. There are still very large volumes of oil sitting in storage, but inventories have already started a slow drawdown. The OPEC deal could kick those drawdowns into high gear.

In other words, oil prices have shot up sharply on the news already – WTI and Brent were up more than 8 percent by midday Wednesday – but more gains could be coming as OPEC is set to severely tighten the market. The surprise move will add more fuel to the fire for prices, which were already set to climb in 2017 even without a deal. Goldman Sachs wrote in a research note earlier this week that the “[p]rice risk is likely skewed to the upside heading into Wednesday,” adding that “even in the absence of a cut, we expect the oil market to move into deficit by the second half of 2017.”

Very few analysts thought that OPEC would be able to pull off the deal that they just announced. Of course, the burden will be on OPEC to actually implement the deal and take physical barrels off the market, not just promise to do so. But as of now, OPEC just upset everyone’s forecast for oil prices going forward. The EIA, for example, saw oil prices averaging just $49 per barrel next year. OPEC’s surprise deal means that oil watchers are going to have to go back to the drawing board and substantially revise up their forecasts for crude prices in 2017.

Following yesterday’s 8.65% rise, the United States Oil Fund LP ETF (NYSE:USO) was up $0.20 (+1.83%) to $11.13 per share in premarket trading Thursday. Year-to-date, the largest ETF tied to WTI oil prices is still down 0.64%.


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