How Opec and its allies seek 'nirvana of balance' with reduced oil output

The key concept in the wake of the decision to reduce crude oil output by Opec and its allies is "balance". It's something everybody in the market says they want, but they all have different ideas of what it means and how to get there.

Boiled down to the basics, both the Organization of the Petroleum Exporting Countries and the other producers, most notably Russia, are trying to do with the move to cut output by 1.2 million barrels per day (bpd) is achieve their vision of a balanced market.

While what this means is not exactly spelt out in unambiguous terms, it's assumed to mean that they want an oil price they believe to be "fair" and one that will allow them to meet their fiscal obligations as well as ensuring sufficient incentive for capital spending to maintain future output.

What this means for the price of crude oil is less than certain, although it's likely that OPEC and its allies will take the view that the $60.06 a barrel that Brent crude closed at the day before the Dec. 7 output deal was reached is too low.

But it's also apparent that in the current climate an oil price above $80 a barrel will result in fairly rapid demand destruction and rising output from producers outside the OPEC orbit.

Brent reached a four-year high of $86.74 a barrel on Oct. 3, but a mere eight weeks later it had shed almost 34 percent of its value, hitting a trough of $57.50 on Nov. 28, the lowest level in a year.

It's that rapid plunge that led OPEC and its allies to conclude that the market was no longer in balance, and that output needed to be cut to return to the desired, but elusive, state.

The market will now get to deliver its verdict on whether OPEC has once again baked a magic pudding that will allow crude prices to rise, but not so high that demand is threatened.

The initial price action after the announcement of the deal was mildly positive for OPEC, with Brent jumping as much as $3.67 to $63.73 a barrel during trade on Dec. 7, but eventually it closed at $61.67, up 2.7 percent from the previous day.

TRUMP, IRAN

The nirvana of balance also means that OPEC, and in particular its largest producer and de facto leader Saudi Arabia, have to walk a series of political tightropes.
 

The obvious one is also the most public, U.S. President Donald Trump, who is often criticised for changing his mind on issues, but has been remarkably consistent on one front, namely his desire for lower oil prices.

It's perhaps no surprise that Saudi Energy Minister Khalid al-Falih singled out U.S. energy companies as winners from the OPEC and allies deal, telling reporters at the meeting in Vienna on Dec. 7 that they were "breathing a sigh of relief".

This was perhaps a not-so-subtle attempt to stave off a blast from Trump on his favoured social media platform Twitter, by reminding him that the powerful U.S. energy lobby is no friend of his push for ever lower oil prices.

The Saudis also have to manage their relationship with the United States carefully in the wake of the murder of Saudi dissident journalist Jamal Khashoggi at the kingdom's consulate in October.

Trump has said he is not convinced the Saudi crown prince ordered the murder, even as leaders of his own Republican Party make noises about imposing stiff sanctions on Saudi Arabia for the killing.

A further complicating factor is Iran, which is exempt from the new output-cutting deal, and in theory living on borrowed time given the U.S. waivers on its oil exports are due to expire on April.

Given the plethora of competing factors and influences, it would seem balance will be a difficult, if not impossible task in the crude oil market.
 

But how will the success of this latest production cut be measured?

If crude remains in a range between $60 and $80 a barrel in the run up to the expiry of the Iran export waivers, then it might be fair to argue that OPEC and its allies will have achieved what they wanted - a floor and a ceiling that everybody can live with.