So far, market psychology has worked profitably for the Organization of Petroleum Exporting Countries and its collaborators in supply management. Mere discussion about production cuts raised the price of crude oil enough to generate windfall revenue last month.
The International Energy Agency estimated in December that crude prices jumped $7/bbl after OPEC's Nov. 30 agreement to trim group production by 1.2 million b/d. Prices jumped a further $3/bbl after the Dec. 10 agreement by Russia and 10 other producing countries to lower aggregate production by 558,000 b/d.
Profiting from agreement
The baseline for OPEC's cuts is 33.7 million b/d-the September and October rates that set records until group output rose to 34.2 million b/d in November. The agreement didn't take effect until Jan. 1. If OPEC members produced at the baseline level in December, group revenue with the crude price elevated by $7/bbl for 10 days and by $10/bbl for the rest of the month was $9.4 billion higher than it would have been without the price jumps. The revenue gain for OPEC natural gas liquids at 6.9 million b/d, assuming comparable price moves, was about $1.9 billion. For the record-high 11.2 million b/d of crude and condensate Russia was producing in November, December's two-step price adjustment boosted the month's revenue by perhaps $3.1 billion.
These adjustments occurred for two reasons. OPEC and a group of non-OPEC producers dominated by Russia agreed to restrain production. And expectations ran high in December that they would do what they said they would. Market psychology thus rewarded OPEC members and Russia by roughly $14.4 billion even before parties to the agreement needed to sacrifice output. That's not enough to solve Saudi or Russian fiscal problems. But it's good money for a couple of communiques. And it's politically helpful to governments needing to assure domestic audiences they're acting on the price of crude.
The difficult test has just begun, though. During the agreement's initial 6-month term, much can happen. Oil supply from shale and tight-oil plays in North America might rebound enough to soften crude prices. Or prices might climb enough to make participating producers abandon the agreement. Or OPEC producers, led by Saudi Arabia, and Russia might lose faith in each other's commitment to the deal. Or Saudi-Iranian tension might snap.
Early signs are encouraging. According to a Jan. 13 report by Sam Margolin, Jason Gabelman, and Tanner Strunk of Cowen & Co., ship monitors say total OPEC exports were down 1.5 million b/d from October levels in the first 10 days of January. Exports by Russia, which agreed to cut production by 300,000 b/d, were down 500,000 b/d. But the Cowen analysts think most of the Russian decline resulted from increased refinery runs. Early-month Russian production might have been down by only 50,000 b/d, they say.
For OPEC and Russia, revenue inducements are in place. OPEC crude oil production at the target level of 32.5 million b/d yields $1.69 billion/day at a crude price of $52/bbl. Production at the baseline level and a price $10/bbl lower would generate $270,000/day less for the group as a whole. Of course, aggregate numbers might not be compelling to individual OPEC members unhappy with their assigned targets or otherwise aggrieved politically. Russia, too, might generate more revenue by producing less: $566.8 million/day if producing 10.9 million b/d helps keep the crude price at $52/bbl vs. $470.4 million/day with production remaining at 11.2 million b/d and the crude price back at $42/bbl.
Making it work
These calculations simply illustrate possibilities. They assume other variables remain constant, a condition markets and politics won't allow. They suggest that parties to the effort to coordinate production profited from merely reaching an agreement and have dollar-denominated incentive to make the deal work.
Extra incentive should come from the power of market psychology evident in December. If high hope about a production agreement was worth $10/bbl, who knows what disappointment over the agreement's failure might cost?
