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Saudi Arabia wants higher prices

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Opec output
OPEC surprised the market with an agreement to reduce output

Yesterday OPEC agreed a production target lower than their current output, signaling they are prepared to make sacrifices to ease the global oversupply. The group will limit crude output at 32.5-33.0 mbd from 33.24 mbd in August. It is not decided how the proposed cut should be shared out between member countries. Many of the details remain to be worked out in OPEC’s next meeting at the end of November, when an invitation to join cuts could also be extended to non-OPEC countries such as Russia.

Oil prices are well below budget needs of most OPEC producers, but earlier attempts to agree on output has been complicated by the strained relations between Iran and Saudi Arabia.

The Saudi Energy Minister said that Iran, Nigeria and Libya would be allowed to produce “at maximum levels that make sense” as part of any output limits. This is a shift from the earlier strategy that Saudis would only limit output if every other producer followed suit. Iran has argued that it should be exempt from production limits after the lifting of sanctions earlier this year. Saudi Arabia is by far the largest OPEC producer with output of 10.7 mbd. Iran’s production has stagnated at 3.6 mbd over the past three months although the target was to ramp up to more than 4 mbd.

Saudi Arabia faces a second year of budget deficits after a record gap of $98 bn last year. Iran is suffering less from the drop in crude prices, and the IMF expects its economy to expand by 4% this year.

Russia has indicated a will to make a contribution to see a quick rebalancing of the market. However, Russia ramped up its oil production to 11.1 mbd in September, the highest monthly average since Soviet times.

US shale production is declining, but since May the number of rigs drilling for oil in the US has been rising. The break-even price of producers has been lowered thanks to cost cuts and productivity gains. If oil prices rise, US producers will be able to accelerate their recovery, bringing more rigs back to work and more wells into production. US production is expected to recover next year, but at a lower rate than before the collapse.

The OPEC deal will not be a game-changer for oil markets. The agreement surprised the market, but skepticism over the implementation of the deal will contribute to continued volatility over the next two months.

The oil market is already tightening. Demand growth now exceeds supply growth and surplus stock levels will be reduced. This will gradually push prices higher through 4Q16 and next year. Higher prices are needed to create new supply after a period of huge investment cuts.


US rig prod endSep

Data. EIA, ThomsonReuters
Updated