OPEC is back on the international stage. For the first time since the 2008 crisis, its 14 members agreed to cut their overall oil production. After two years of falling oil prices, they did not have a choice. In the Persian Gulf in a move to save money, Saudi Arabia, the world’s top oil producer, has cut some state workers’ salaries. European oil companies and American shale producers have struggled since the sharp decline in the price of oil. More broadly, two years of low prices have diminished investors’ confidence in the oil industry and threatened political stability in Venezuela and Nigeria. In a nutshell, precarious fiscal situations, bearish investors, bankruptcies and social unrest pushed OPEC’s members to reverse their free-pumping policy.

 

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OPEC Members

 

The 14 oil-producing nations, who met in Algiers on 28th September 2016, reached an agreement to cut output. The markets welcomed the news and the Brent prices increased by 17 percentage points between 28th September ($45.75) and 10th October ($53.70). However, the most difficult challenge lies ahead: deciding on the details of the cut. Determining who was going to shoulder the cut remained a thorny issue. Iran, who endured several years of international sanctions until January 2016, was clearly not willing to freeze production. Iran’s attitude upset its main rival, Saudi Arabia, which had already stopped a deal attempt for the same reason earlier this year. Libya, Nigeria and Iraq, which have recently suffered armed conflicts, seemed to share Iran’s view. Amid concerns that a deal would not be reached, the Brent prices dropped again to under $44.

Despite these disputes, the members of the oil producers’ cartel, who met in Vienna on 30th November, agreed on the output cut of 1.2m barrels a day (b/d), from 33.7m b/d to 32.5m b/d. Saudi Arabia and its Gulf allies, UAE, Qatar and Kuwait will take a significant cut: 786 000 b/d. Iraq reluctantly agreed to cut 210 000 b/d while Iran was allowed to increase its current production by 90 000 b/d.

This apparent increase, in fact, represents a 4.5% production decrease compared to pre-sanction levels. Libya and Nigeria were not impacted. A few days later, on 10th December, Russia and 10 other non-OPEC producers decided to cut their output by 558 000 b/d. The combination of these two deals made investors bullish. Oil producers now enjoy a price well up ($56.87) from the lows it hit in January when, at one point the barrel of Brent approached $27, its lowest since 2003. A couple of analysts see crude hitting $70 per barrel in 2017, but the consensus is that crude will stabilise in the mid-$50s.

On the other hand, low oil prices also had a positive aspect. Oil companies understood that they had to prioritise profitability. In order to guarantee higher returns, they will have to drill in areas with easy access, to focus on existing reserves, to reduce their inventories and to improve their manufacturing processes. High-costs U.S. shale producers were the main targets of OPEC’s free-pumping policy. They successfully cut their production costs by 15% to 20% and a few of them could make money out of a barrel at $30. They are now ready to steadily increase their production. Ironically, their newfound health could offset the effects of OPEC’s deal.

Oil-producing countries are now trying to trim their dependence on oil to diversify their economies. In October 2016, Saudi Arabia, the world’s top oil producer, did its first issuance of dollar-denominated bonds. The Kingdom is barely in debt: this is why investors were looking at this $17.5bn bond sale with envy. Saudi Arabia will continue to need investors’ confidence in the future as it plans on issuing sovereign bonds every other year. Moreover, the sale of up to 5% of Saudi Aramco, Saudi Arabia’s state oil producer, is the next step of this diversification strategy and will take place in 2017. Some Gulf countries even invested in renewable energy and batteries. Oil still reigns over the energy industry, but its days seem to be numbered.