Two years ago, global oil prices crashed after the world started pumping out far more crude than anyone needed. That plunge, from $100 per barrel down to $40 per barrel, upended the global economy — and cost oil producers like Saudi Arabia billions of dollars in lost revenue.
Now those oil producers have had enough. On Wednesday, the Organization of the Petroleum Exporting Countries reached a tentative deal to cut back on oil production by 1.2 million barrels per day in order to raise global prices. (OPEC is a cartel of 14 major oil exporters, including Saudi Arabia, Iran, and Iraq, that account for 40 percent of global production.)
OPEC nations currently produce about 33.7 million barrels of oil per day. Under the deal, they’ll bring that down to 32.5 million barrels per day — with the precise allocation of cuts still waiting to be hashed out. Earlier, the talks had stumbled as Saudi Arabia tried to convince Iraq and Iran to reduce production. Both countries have been trying to increase oil output in recent months as they emerge from war and sanctions, respectively.
Global oil prices rose nearly 8 percent on the news, with Brent crude rising from $46 per barrel up to $50 per barrel. Those prices, however, are still far lower than they were back in 2014, when prices first crashed:
That said, there’s a lot that’s still uncertain about this deal. It depends, for instance, on non-OPEC countries like Russia also agreeing to rein in production. Meanwhile, there’s the question of what happens in the United States. Over the past year, as prices have bottomed out, many fracking companies in North Dakota and Texas have idled their rigs. If prices go up, those companies could start drilling again, putting more crude on the market and causing prices to fall again.
The stakes are high. The price of oil matters for everything from what drivers pay at the pump for gasoline to the trajectory of the global economy. Which is why the whole world is paying attention to the machinations of OPEC, the world’s most famous cartel.
Why OPEC is trying to cut back on oil production — after doing nothing for two years
For the past two years, as oil prices have been plummeting worldwide, OPEC has mostly stood by and watched, unable to reach a decision on how to react.
The cartel's most important member, Saudi Arabia, famously refused to cut output in 2014 when prices first began sliding, because officials were hoping the resulting price crash would drive large swaths of the US fracking industry — with its higher production costs — out of business. The fracking boom in North Dakota and Texas, after all, was a big reason the oil market was oversupplied.
“At the time, that decision to let oil prices drop made sense,” explains Jason Bordoff, founding director of Columbia University’s Center on Global Energy Policy. At the time, Saudi Arabia didn’t want to cut back on production and lose market share only to see other producers reap the benefits — a “historic error” the country made when prices fell in the early 1980s.
But the world has changed a lot over the past two years. US production has fallen from 9.6 million barrels per day down to 8.6 million barrels per day amid the price crash. Nearly $1 trillion in oil investment worldwide has dried up. Iran returned to the oil market after EU and US sanctions were lifted as part of the nuclear deal. Meanwhile, Saudi Arabia has been hurt badly by the price crash. The country has already burned through $160 billion worth of foreign exchange reserves and has been forced to cut social services and salaries to compensate for lower oil revenues, threatening stability in the kingdom.
So the Saudis finally decided to shift their stance. Back in September, OPEC’s 14 members agreed to set a short-term ceiling on their overall output between 32.5 million and 33 million barrels per day. The hope was that by cutting output, OPEC countries could boost prices and ease the pain on their budgets without immediately triggering a massive surge in new oil investment that would lead to another glut and crash.
The details of OPEC’s deal are still being hashed out
So far, OPEC's members have agreed to an overall cut of 1.2 million barrels per day. But the difficult decisions involve which countries actually makes the individual cuts to help reach that total. Those details are still leaking out in press reports.
According to Reuters, Saudi Arabia plans to cut about 500,000 barrels per day by reducing output to 10.06 million bpd. Iran plans to freeze output at close to current levels of 3.797 million barrels per day. Other members will also cut production.
Meanwhile, before the meeting, Saudi officials said that they hoped non-OPEC countries like Russia would contribute an additional 600,000 barrels per day worth of cuts.
A deal like this is never easy to reach. Every OPEC country is in a slightly different situation with different interests, says Jim Krane of Rice University's Center for Energy Studies. Iraq and Libya are emerging from civil wars and trying to increase their output, and tend to argue that other countries should bear the burden. Saudi Arabia doesn’t want to go it alone on cuts and lose too much market share. Iran is trying to attract new investment to rebuild its sanctions-ravaged industry and is worried that too steep a cut might scare off investors.
So OPEC constantly faces a big coordination problem. All of its members would benefit from higher global prices, because that would mean more revenue for their budgets. But no individual country wants to be the one to bear the heaviest burden — because it would then lose market share and revenue.
What’s more, even if OPEC's members agree to detailed production cuts, countries could always cheat and fail to reduce output in practice. “That’s something we’ve absolutely seen in the past,” says Bordoff. In particular, pledged cuts from outside of OPEC often prove suspect.
The US fracking boom makes OPEC’s decision much more complicated
Even if this deal is successful, however, OPEC faces another, more serious quandary. Over the past two years, the fall in oil prices has put a damper on project investment in places like the United States and Canada and Brazil, because fracking and oil sands and deepwater companies need relatively high prices to make investing in costly new projects worthwhile. That crimp in investment has helped stabilize prices around their current level.
But if OPEC successfully throttles back on production and hikes prices, that could induce some fracking companies in Texas or North Dakota to start drilling again. At that point, supply would rise and prices would fall. OPEC would be right back where it started — except it would have lost market share.
The tricky part is that no one knows exactly how this dynamic would play out. Bordoff notes that forecasts vary wildly on how much US oil production could grow again if prices rise to, say, $60 per barrel — some analysts suggest an extra 300,000 barrels per day, others 900,000 barrels per day. “It’s a big uncertainty range,” he says.
Part of this is uncertainty about the “break even” point for many projects in the United States — the price at which it’s profitable to drill. During the price crash, many fracking companies managed to slash costs and reduce their break-even price, but it’s unclear if that was due to sustainable efficiency improvements or unsustainable moves like squeezing suppliers or focusing only on the most productive wells (which they can’t do forever).
“The uncertainty about US shale is a huge game changer for OPEC,” Bordoff says. “If prices rise to $60, and a large volume of oil can come back quickly, that’s a very significant constraint on the ability of OPEC to manage the oil market that we haven’t seen before.”
The popular view of OPEC is that its members can sway the global oil market with a single utterance. We saw this in 2008, when prices were plummeting amid the financial crisis and OPEC stepped in to halt the slide. But OPEC doesn’t have the same power it used to. Over the past two years, the cartel has been paralyzed by indecision, watching as US shale drillers flood the market and swing global prices. Saudi Arabia is now trying to reassert its grip.