The cartels arrangement hammered out in Vienna may put a floor under the price of crude, but Saudi Arabia has failed to destroy the US fracking industry

Two years of wrangling were needed before Saudi Arabia and the rest of the Opec oil cartel could agree a cut in production at its meeting in Vienna last week.

Ever since the breakdown in crude prices in 2014, the big oil-producing countries have plotted a way to regain control and improve their battered finances. But agreeing which countries would bear the ache of the steepest production cuts had proved an insurmountable challenge.

That barrier demonstrated less formidable once costs stayed persistently low into 2016. With a recovery in the crude marketplace nowhere in sight, ultimately one member after another fell down line at Vienna and crucially Russia, a non-Opec producer, agreed to a cut of its own.

It means that for UK motorists the days of 1-a-litre of petrol are likely to fast become a distant memory.

It was only back in January that the price of a barrel of Brent crude tumbled towards $27 and some analysts forecast that it could reach as low as $10. There was pleasure among western leaders who dared to believe that the era of stellar economic growth that characterised the 1990 s, fuelled as it was by super-low oil prices that rarely pushed above $20 a barrel, was about to return.

But a long run of ultra-cheap prices was not to be; Brent quickly bounced back and spent the rest of the year moving between the $40 – $50 mark. None the less, Opec, which produces a third of the worlds crude oil, wanted more and announced that it would cut production by around 4 %, or 1.2 m barrels per day, to bring output down to 32.5 m barrels per day in January. The cut is an effort to set a $50 -a-barrel floor under the price and move it towards $60 a barrel within a few months.

Mihir Kapadia, chief executive of fund administrator Sun Global Investments, says: Petroleum costs are genuinely on course for a recovery. The first coordinated action by the Opec members in eight years has definitely defined a new price outlook for the commodity. The longer-term impact on oil price will depend on the implementation of the accord, and discipline in sticking to the accord.

But few in the oil business expect a return to the prices which predominated the early part of the decade, including the most recent peak of $114 two years ago. It is more likely that a $60 cap will emerge as the Americans, who stand outside the 13 -member Opec grouping, unplug the spigots that have maintained their shale oil fields from rendering in the last year or two. It is the emergence of shale drilling where pumping a mixture of chemicals, water and sand into dense rock releases trapped petroleum that has prevented Opec from controlling supplying and demand in the way it did in the past.

The Ras Tanurah refinery in Saudi Arabia. Photo: Thomas J. Abercrombie/ National Geographic/ Getty Images

Global, and especially US, crude oil inventories are currently at extremely high levels after two years of massive oversupply, Socit Gnrale analysts say. While the Opec agreement is very significant and will result in some moderate global stockdraws next year, you are able to take more than one year for crude inventory levels to return to more normal levels.

The return to action of once-idle derricks on the Texas and Dakota plains is the result of efficiency savings that have assured large jobs loss and a more streamlined approach to drilling from the US industry, after the post-2 014 price tumble rendered many operators unprofitable. Merely a few years ago, many firms struggled to make a profit at $70 a barrel. Now they can be competitive at much lower costs, with many expecting $50 for West Texas Intermediate a lighter crude that typically earns$ 5 a barrel less than Brent.

Since the start of June about 25 US oil rigs have been moving into the market every month. Most firms report taking a cautious approach to give themselves time to assess the Opec agreement and whether it will hold.

Analysts at Oxford Economics say the US shale industry is right to be wary. It says a general absence of global demand for petroleum is another downward pressure on costs and will keep them below $60 a barrel, at the least until the end of 2018. A history of Opec governments cheating to improve their revenues by pumping more petroleum to violations of production cuts is also likely to undermine efforts to cut output, they say.

Saudi Arabia, which has long been the main producer and most powerful political operator in the Opec cartel, has dug deep into its reserves to make up the shortfall in its public finances following two years of low prices. It hoped to cripple the US frackers by holding down costs. Under that plan, it would then have ratcheted them up again with a well-timed production squeezing. But the US industry has not collapsed and Saudi Arabia has considered a total budget ravaged as prices bided low, forcing an disconcerted King Salman to cut subsidies and services.

In the wake of the Vienna agreement, Saudi Arabia will lead the way with reductions of 0.49 m barrels a day, with Iraq, the United Arab Emirates and Kuwait taking smaller makes. Other minor reductions have been promised by Algeria, Angola and Venezuela, while Iran which faces the reinstatement of sanctions by an incoming Trump presidency was allowed to freeze or marginally increase output.

Fuel being delivered to a petrol station in London. Photograph: Bloomberg via Getty Images

Last Friday, the new strategy appeared to be working. The spot cost of Brent crude managed to break out of the $43 – $54 scope that has been the norm since mid-April, giving a lift to the revenues that oil producers crave.

But with the US shale producers still in play, the move is likely to set a floor under the price merely , not send it into the stratosphere.

Oxford Economics says that, cheating aside, weak demand due to the state of the global economy is one of the biggest barriers to high prices. The fragility of the Vienna deal, and the six-month timescale to implement it, are another two elements maintaining forecasts muted.

Russia, which is not an Opec member and produces about as much petroleum as Saudi Arabia, counts as a further reason for caution. It is supposed to be part of the new arrangement, and officials in Moscow are scheduled to announce production cuts next week. The press conference is likely to go ahead, but analysts are sceptical there will be a significant move to cut production when petroleum revenues make up most of the Russian governments income.

Joshua Mahony, marketplace analyst at spread betting firm IG, says: A likely rise in US output, in response to higher prices, and an increasing rig count will counteract some of[ the production] cut, while the opaque nature of national petroleum output mean that enforcement is likely to be unreliable at best.

Enforcement of the Vienna deal is the key to preventing oil prices from falling again. But the interaction of supply and demand, most of it outside Opecs control, means that for the next couple of years, costs are likely going nowhere fast.

Who benefits?

BP and Shell The prospect of a cut to production from January lifted oil prices last week and with them the shares of energy companies. Royal Dutch Shell and BP were the biggest gainers in the FTSE 100 on the day of the bargain, on predictions petroleum could climb to $60 a barrel.

Nicola Sturgeon The prospect of higher oil prices should bring some relief to Scotlands first minister. More than a year of oil prices around or below $50 has put pressure on the North Sea oil industry. Crude in the region has become increasingly tricky to reach and lower returns stimulate investing in petroleum extraction harder to justify. That in turn has cost chores, hit taxation receipts and blown a hole in Scotlands public finances. Scotlands deficit ballooned last year as its share of North Sea oil tax revenues collapsed to 60 m from 1.8 bn the previous year.

Shale A combining of weak demand and a decision by Saudi Arabia to keep production levels high had pushed oil prices down sharply since the summer of 2014. Riyadhs hope was that low crude prices would push higher-cost US shale producers out of business. But it didnt: and now that prices have risen, shale fields in the US are expected to ramp up their production.

Motorists Petrol costs are set to rise after the Opec deal sent petroleum surging. In the UK, petrol costs could increase by as much as 9p a litre, adding virtually 5 to the cost of filling up an average family automobile, according to motoring organisations. Higher oil prices could also push up household energy bills as wholesale gas tends to track the price of crude. But petrolheads loss could well be environmentalists gain, if higher pump costs push people towards electric cars or just into driving less.

Saudi Arabia The kingdom flooded the markets with inexpensive crude in a bid to kill off US shale, but now it has effectively admitted defeat; Saudi is bearing the brunt of Opecs production cut. On the other hand, it stands to gain a little from a higher oil price: that would offset some of the pain from production cuts and induce the stake in country oil producer Aramco, which it is planning to float, more valuable.

Airline Carriers have benefited from cheap fuel over the last two years but now their costs seem set to start rising again. Shares in airlines, including Ryanair and easyJet, fell as Opec reached its deal.
Katie Allen

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