OPEC’s agreement to cut output for the first time in eight years has helped push up oil prices by nearly 10 per cent in the last week, but will the agreement hold and how will it impact UK business?
Brent Crude has risen back above $50/barrel in the wake of the deal that will see the cartel cut production by 1.2 million barrels a day from the start of January – with an option to extend for a further six months.
The deal represents a significant compromise by Saudi Arabia, which had previously been reluctant to cut output in an effort to squeeze out US shale and other high-cost producers.
OPEC’s second-largest producer Iraq has also agreed a significant reduction, while Iran will freeze output at current levels, despite only recently having had sanctions lifted.
A failure to enforce past agreements means there is understandable scepticism that the deal will hold, though the fact that some non-OPEC countries, including Russia, have also agreed to participate by cutting output is an encouraging sign.
OPEC, whose members produce about one-third of the world’s oil, has also pledged to create a monitoring committee including non-member nations to make sure everyone stick to the deal, rather than relying on member’s own production data as proof.
Shortages and shale
The big question is whether the deal marks the start of a more sustained rise in oil prices.
If the cuts are fully implemented, they should lead to an oil shortage in early 2017.
However, there is a risk that US shale oil producers could use the resulting rise in prices as an opportunity to increase supply, while the price gains could also dampen demand, both potentially helping keep prices in check.
On the other hand, the pro-growth policies of the new Trump administration, and the possibility that the new president reintroduces sanctions against Iran, could clearly put upward pressure on prices.
On balance, we are cautiously optimistic that OPEC’s announcement will help to redress the long-standing glut in global oil supply.
In the absence of a sharp fall in world growth next year, we’d expect oil prices to move steadily higher, hitting around $70 a barrel by the end of 2017.
Pressure on prices
For UK businesses, the link between the oil price and the cost of other forms of energy should put upward pressure on the cost of domestic gas and electricity. The potential for a further weakening of sterling could also exacerbate the impact, as oil prices are quoted in US dollars.
And even with oil prices at current levels, there are already clear strains in the domestic electricity market.
Prices spiked last month after below average temperatures and nuclear power outages in France. National Grid has also warned of low levels of excess capacity, thanks to the retirement of older power stations combined with less reliable renewable sources.
The lack of investment in new electricity generation has left wholesale – and retail – electricity prices particularly prone to sudden increases in demand or disruptions in supply.
It could be an expensive winter.