Economic implications of the OPEC deal

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The Brent oil price roared higher overnight as OPEC and Russia agreed 1.5mb/d in cuts. Henry Hub firmed to $3.34mmBtu:

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As expected, OEPC agreed cuts:

The global oil market has witnessed a serious challenge of imbalance and volatility pressured mainly from the supply side. It has led to significant investment cuts in the oil industry, which has a direct impact on offsetting the natural depletion of reservoirs and in ensuring security of supply to producers.

Current market conditions are counterproductive and damaging to both producers and consumers, it is neither sustainable nor conducive in the medium- to long-term. It threatens the economies of producing nations, hinders critical industry investments, jeopardizes energy security to meet growing world energy demand, and challenges oil market stability as a whole.

There is a firm and common ground that continuous collaborative efforts among producers, both within and outside OPEC, would complement the market in restoring a global oil demand and supply balance, in particular the drawdown in the stocks overhang, which is currently at a very high level.

At this conjuncture, it is foremost to reaffirm OPEC’s continued commitment to stable markets, mutual interests of producing nations, the efficient, economic and secure supply to consumers, and a fair return on invested capital.

Consequently, the recovery of oil market balance could be addressed through dialogue and cooperation among producing countries as a way forward for cohesive, credible, and effective action and implementation. Hence, it is under the principles of good faith that countries participating in today’s meeting agree to commit themselves to the following actions:

1. In the fulfilment of the implementation of the Algiers Accord, 171st Ministerial Conference has decided to reduce its production by around 1.2 mb/d to bring its ceiling to 32.5 mb/d, effective 1st of January 2017;

2. The duration of this agreement is six months, extendable for another six months to take into account prevailing market conditions and prospects;

3. To recognize that this Agreement should be without prejudice to future agreements;

4. To establish a Ministerial Monitoring Committee composed of Algeria, Kuwait, Venezuela, and two participating non-OPEC countries, chaired by Kuwait and assisted by the OPEC Secretariat, to closely monitor the implementation of and compliance with this Agreement and report to the Conference;

5. This agreement has been reached following extensive consultations and understanding reached with key non-OPEC countries, including the Russian Federation that they contribute by a reduction of 600 tb/d production. In testimony of the above-stated the undersigned, authorized by their governments, have signed this Agreement.

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Wider participation that I expected suggesting the entity is not entirely dead. With Russia’s extra 300k b/d it’s a decent cut at -1.5mb/d. It does almost exactly what I expected to the oil market balance as Libya keeps coming and the US rebound accelerates:

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It’s not an end to the oil glut but it is downside protection. I’ll lift my oil outlook back to $45-55. The glut persists but OPEC has proven it is back so builds in a cartel premium despite the reality that its members will all cheat.

The economic implications are simple. Oil is not going to offer any further disinflation. I doubt it will offer much inflation, either, except in the US. That will come not via the oil price itself but via wages in a resurgent shale oil boom, from Deutsche:

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Hence the number one macro implication of the deal is not so much higher oil as it is a higher USD as the Fed’s path for rate hikes firms again. That comes with all of the usual implications:

  • further selling in global bonds;
  • confirmed USD bull market;
  • a falling Aussie dollar;
  • a major headwind for commodity prices, and
  • a major headwind for emerging market growth.
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It does not change the outlook for global growth only shifts its winners and losers. The US is a bigger winner, other oil producers are neutral, wider EMs and other commodities are worse off. In terms of sectors, interest rate sensitive keeps getting flogged. Non-mining cyclicals keep rising. Miners will roll when China pops the futures bubble for good.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.