The OPEC Deal May Tell A Different Story

The recent OPEC deal is an effort to stabilize oil prices; but consequences could deviate from policy directions.

The OPEC deal reached at Vienna between cartels to reduce production has created excitement and fears alike, among oil importing nations. The recent deal has pushed oil prices higher, after a two-year lull of stagnation and decline. Russia, a non-OPEC economy, which could secretly gain from this deal to expedite their oil production and capitalise on importing nations, agreed to reduce production to stabilise global oil prices; even if it means that Russia alone must shut down close to 4000 wells.

A single, pertinent question remains: With economies making great strides and efforts to reach an agreement for production cuts, can oil prices reclaim the older highs of 2008? It seems more unlikely, considering non-members’ freedom in non-compliance, and OPEC’s behaviour of cheating its own commitments in the past. All oil producing nations never bend to let go of their market share, and are also disposed to cheat to gain a bigger chunk.

OPEC nations have primarily imposed the cut to stabilise oil prices, and to let it rise as demand grows and equalises supply. Non-OPEC members may cite multiple reasons or non-cooperation. Stances like that of the Saudi minister only ascertain that the production cut may be just temporary, given that it is a conditional agreement.

The basic question of cutting production remains a mystery to them.  In a profit seeking global economy, cutting production in a demanding market is rather impossible, especially when non-OPEC members are not officially bound to OPEC policies. OPEC countries are targeting a price in the $55-$60 per barrel range, but analysts expect it to go even higher if all oil producing nations are able to curb production. If oil prices remain in the $55 range, Russia could make an additional $15 billion in revenues, since its budget was based on a price of $40 per barrel.

Net oil importers will experience turbulence in budget deficit and trade values; they may be compelled to shell out more for oil import or to dig their own oil wells to trade-off the rise in import costs. Economies may become attractive with stabilised oil prices, and trading volumes can be expected to rise. Rising demand in developing countries like India, China, and other Asian and African countries will keep pushing oil demand, putting pressure on OPEC to review their production cut. If the deal is implemented as it is assumed to be, there could be a major shift in oil importers analysis pertaining to oil sellers, including non-OPEC members. Developing countries are largely to lose in terms of adjusting their budget constraints, tackling currency export, and meeting rising oil demand. However, a prudent policy initiative, keeping buffers for unplanned investments will not dent net oil importers, when their currency is gaining pace with exports in non-oil sectors.

Now, with Russia committing to a production cut, and the intricacies of OPEC and non-OPEC members’ coordination, and cross monitoring yet to be formulated, the consequences of the agreement could be anyone’s guess. Economies like Russia, Mexico, Kazakhstan, and others could actually benefit, being non-OPEC members, provided their commitment of production cut undermines total exports of oil in the global scenario. Implementing the agreement has immediately influenced oil prices. What remains to be seen is the response from Russia and other non-OPEC members to further cooperate in production cuts.

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