BIG BUMP

Oil prices are surging by 8% on the surprising word of a huge cut in production

Obsession
Energy Shocks
Obsession
Energy Shocks

After two years of suffering, major oil-producing countries—their national budgets stretched to the breaking point—seem to be finally acting, with a huge 2% potential cut in the global supply of crude. The news snapped the Brent international benchmark out of several weeks of topsy-turvy pricing and up over $50 a barrel, an increase of as much as 8%.

The scene of action is Austria, where OPEC producers are meeting today. The price surge occurred when ministers from Saudi Arabia and Iran, arriving in Vienna, separately told reporters they are “optimistic” that a deal will be reached. Bloomberg reported that, between OPEC and non-members of the cartel, there will be a reduction of 2 million barrels a day to global supply, currently at 97.2 million barrels.

Saudi oil minister Khalid al-Falih explicitly said his country is prepared for a big cut, and to act even without Russia doing so simultaneously. Russia, one of the world’s top producers but not an OPEC member, will cut only after OPEC does so first, Falih said (video), which would be an enormous leap of faith by the ordinarily suspicious Saudis.

Despite the assurances, the cut is not certain because OPEC has tried and failed numerous times over the last two years to come to agreement. In addition, cartel members are notorious for cheating after agreeing to cuts. Moreover, there is no guarantee that non-OPEC members such as Russia, Azerbaijan, and Kazakhstan will follow suit, since there appears to be little or no leverage to obligate them—apart from perhaps the possible dishonor of violating a verbal agreement with Falih.

Another wrinkle is US shale oil drillers, who definitely will make no cuts. They are the producers of an unexpected supply of millions of barrels of shale oil over the last five years, triggering the plunge in oil prices that began in June 2014. After pulling back production by hundreds of thousands of barrels a day because of the lower prices, shale drillers have been going back to work in recent months, adding 50% more operating rigs since May.

If OPEC’s cut does materialize, the higher prices are likely to lure even more rigs back to work, thus eroding at least some of the reduction, and effectively capping the price increase.

Still, after much doubt has been cast on whether it remains the potent global force it has been since the 1970s, OPEC would be demonstrating that it retains its levers of power.

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