Will Oil Prices Continue to Rise?

After months of negotiations and a number of high-profile failures, the OPEC group of oil producing countries, together with Russia, reached a deal on cutting oil production over the first six months of 2017.  This deal was sealed by a hard-fought agreement by bitter rivals Saudi Arabia and Iran that was brokered by Russian President Vladimir Putin, who’s country, much like most other oil producing countries, has been hit hard by the fall in oil prices over the past 30 months. 

In fact, it was a new downward trend in oil prices in recent weeks that finally convinced OPEC members and Russia that oil output cuts were needed to prevent the price of oil from falling even further.  With oil supplies remaining abundant, and with oil demand failing to meet expectations in recent years, the downward pressure on the price of oil was proving overwhelming.  Now that this deal has been reached, oil prices have risen by more than 15% in recent days.  However, there is a great deal of concern among OPEC member states and Russia that, even with this deal, oil prices may fail to continue to rise, and could even trend downwards again in the near-future. 

The scope of this deal came as quite a surprise to most analysts, given the acrimonious attempts to reach any sort of deal on capping oil output in recent months.  Moreover, this is the first agreement on reducing oil output in the last eight years, as the world’s major oil producing countries have been unable to work together to manage oil prices during that time.  Overall, the deal calls for oil output among the member states of OPEC to be reduced from 33.7 million barrels per day to 32.5 million barrels per day. 

Much of this reduction will come from Saudi Arabia, as the deal calls for Saudi oil output to be reduced by 486,000 barrels per day.  While this may seem like much, this reduced level of output will be near that country’s output levels from earlier in this decade.  Meanwhile, Iran agreed to cut oil output by 4.5%, but this too was not a major concession, as that country needs massive amounts of investment in order to boost its production capacity over the longer-term.  Finally, Russia (not a member of OPEC), agreed to cut its oil output by 300,000 barrels per day, although the details of Russia’s proposed production cuts remain murky.  Altogether, analysts were not expecting such large production cuts stemming from any such deal, hence the sharp rise in the price of oil since the deal went public.

A number of key factors made this deal possible at a time when many experts were growing more skeptical over the prospects for such an agreement.  First, the lower oil prices of the past 30 months had devastated the financial health of many OPEC member states, particularly its smaller producers.  Even Saudi Arabia began to feel the strain of lower oil revenues as its efforts to support its fast-growing population are becoming more expensive each year. 

Likewise, Russia’s economy has been in a recession for the past two years due to a combination of lower oil prices and international sanctions, as Russia remains dependent upon commodity exports for much of its growth.  This explains Russia’s desire to act as a mediator between Saudi Arabia and Iran, as the latter was particularly reluctant to agree to any reduction in oil output now that it has regained some of its lost access to crucial export markets.  Finally, Saudi Arabia was forced to admit that its efforts to severely weaken non-traditional sources of oil production, such as the shale oil industry in the United States, failed to have the level of impact on these newer producers as they had hoped.

While the immediate impact of this deal was to drive oil prices sharply upwards, there are a number of factors that suggest that this deal might not hold, or that its impact will be rather limited.  First, the deal only covers the first six months of 2017, and there is little indication that some of the parties to this deal might be willing to go along with longer-term oil output reductions.  Second, tensions between Saudi Arabia and Iran are unlikely to dissipate, and Iran is keen to significantly increase its level of oil output in the years ahead.  Third, non-traditional oil producers (such as the US’ shale industry and Canada’s oil sands industry) will certainty raise production levels now that oil prices have reversed some of the declines they recorded over the past 30 months. 

Finally, while this deal will have an impact on the problem of excess supply within the oil industry, it will do nothing to boost the relatively weak levels of demand for oil around the world that have plagued the industry in recent years.  As a result, it is highly unlikely that oil prices will rise dramatically in the coming months, and, should the deal appear likely to collapse or should demand levels fail to reach expectations, oil prices could begin to fall again in the not-to-distant future.