So Opec has done it again and the speculation is over. Oil prices increased sharply by about $5 (Dh18.35) a barrel in one day as the market reacted to the agreement.

The 171st meeting of the Ministerial Conference agreed on November 30 to reduce Opec’s crude oil production for the first time since 2008, in the hope that this would enhance the process of market rebalancing and bring stocks down. Considering the background reports prepared by the Opec Secretariat, the conference followed up on the accord of the 170th extraordinary conference in Algeria in September and decided to implement a new production target of 32.5 mbd “in order to accelerate the ongoing drawdown of the stock overhang and bring the oil market rebalancing forward”.

Analysis shows that this translates into 1.2 million barrels a day (mbd) reduction in crude oil production effective from January 1 for six months. The reduction is based on each country’s production level during October, except for Iran where its pre-sanctions production level was used to accommodate the need for a full agreement without objections or reservations. The diplomatic moves on the part of Algeria and Venezuela in the last two months played a role in bringing about this understanding.

In addition, the President of the Opec conference — Mohammad Bin Saleh Al Sada, Qatar’s Minister of Energy and Industry — announced that some non-Opec producers would reduce their production by 0.6-mbd and that Russia pledged 0.3-mbd of reduction. No wonder then that the market reaction has been positive and Brent and WTI prices climbed to $53.94 and $51.06 a barrel respectively before the day was over.

Implementation

Despite price slides early the next day, perhaps for profit taking, prices resumed upward and as I write Brent and WTI prices stand at $54.12 and 51.34 a barrel, respectively. Perhaps there is little room for prices to rise further as the market focus will now shift to implementation ... and the devil lies in the details. For the next few weeks the market will ponder the numbers and their impact on the process of the much talked about market balance.

Assuming that the agreement will be implemented in earnest and to the full by all participants, then according to Opec, for the first half of 2017, the balancing item between supply and demand is 31.9-mbd which is expected to be provided by Opec and stocks. Therefore the expected reduction in production is just enough to balance the market without reducing the already high level of stocks.

If on the other hand the IEA forecast is used, the balancing item is 32.9-mbd and the agreed reduction is seen to reduce stocks by just over 36 million barrels over the period. Not so much compared with the 300-mb of stock overhang above the five-year average in industrial countries.

Any slip in the implementation of this agreement will cause a proportionate increase in stocks and pressure on prices. Non-compliance has been a feature of many Opec agreements in the past and analysts are rightly concerned that this time around things may be the same. But the suffering of oil producers in the last two-and-a-half years may influence a different behaviour and compliance will be high.

However, the agreement may be undermined by an increase in shale oil production in the US. While the market share advocates were busy trying to wind down shale oil production, producers were working hard to reduce production cost and become more competitive. Technological and efficiency improvements have worked their way to strengthen the shale industry.

Most competitive

For instance, Reuters reported that “the break even cost per barrel, on average, to produce Bakken shale at the wellhead has fallen to $29.44 in 2016 from $59.03 in 2014, according to consultancy Rystad Energy. It added that in terms of wellhead prices, Bakken is the most competitive of major US shale plays.”

The new Opec agreement will encourage increased shale oil production. The same could apply to varying degrees to other high cost producers.

There is no doubt that the agreement is significant especially if compliance is high and the agreement is extended to the end of 2017. The market is said to be “broadly optimistic” but do not expect prices to go beyond $60 a barrel at best.

Most analysts expect prices in 2017 to average between $55-$60 a barrel. If this is a satisfactory level for Opec, the question must be asked whether the market share policy was the only way to arrive at this result.

In 1986, Opec reversed course after few months and this time it took almost two-and-a-half years to do so. Let us hope the lesson has been learnt.

The writer is former head of the Energy Studies Department at the Opec Secretariat in Vienna.