The production cuts agreed by Opec+ will not contribute significantly to raising prices, because of the yawning gap between supply and demand in global markets. Image Credit: Bloomberg

An Opec+ meeting was finally held after oil prices collapsed to record levels not seen in more than 20 years, which meant that decisions from the meeting were mainly aimed at stopping further price deterioration. However, the production cuts agreed upon will not contribute significantly to raising prices, because of the yawning gap between supply and demand in global markets.

Generally speaking, Opec+ countries succeeded in taking the initiative to again lead the markets and achieved one of their most important goals, which is to limit the escalation of US shale oil production. But they paid a high price for it.

Yet OPEC + efforts have led to strategic change. The US for the first time joined ongoing efforts to restrict production in a bid to revive raise prices after a collapse that caused many shale oil companies to go bankrupt and led to US production decreasing by 1.2 million barrels.

Burden on US banks

This necessitated the intervention of major US lending banks to directly put oil and gas fields into operation for the first time in a generation to avoid losses in loans offered to energy companies on the verge of bankruptcy. The US will contribute to the Opec+ reduction agreement, contrary to its previous policy, which represents a big plus for other oil producing countries.

This means the Big 3 - Saudi Arabia, Russia and the US - are now in agreement, for the first time, to cooperate in striking a balance in the oil market and maintaining moderate prices between $50-$60 per barrel.

Such prices are indeed suitable for Opec+ countries and would retain for the US continued production of shale oil, which has become a pillar of the American economy. It is fair to say that this development is a strategic shift in the global oil industry.

Course correction

As per the new agreement, oil production will be lowered by 9.7 million barrels per day as of next May for two months, and by 8 million from July to December, and by 6 million from January to April 2021. Other countries can also join the deal.

Despite this agreement, markets were pessimistic, and this was expected for objective reasons – most of which are temporary. These include the decline in global demand for oil by 30 million barrels per day, due to the near complete suspension of transportation and factories in the world as a result of the COVID-19 pandemic.

This means that even if production is reduced by 20 million barrels - after countries outside Opec+ joined in the production cut - there will remain a surplus of 10 million barrels per day, which will prevent a price boost to the expected levels.

Nevertheless, such an imbalance between supply and demand will be temporary, as there are signs that transportation and factories are resuming in China, the epicenter of the epidemic, as well as in many countries that have begun easing restrictions.

It is plausible to say the deal will contribute greatly in the medium- to long-term to reach suitable price levels for oil producing countries, despite markets not responding favourably to the reduction decision.

At the end of the day, a great obstacle- difference within Opec+ - has been resolved. Their consensus is in fact the guarantee for optimum prices at some point.

Yet, there is still another important factor related - the curbing of the COVID-19 in coming months. This means oil prices will exceed two major obstacles and will regain stability at pre-crisis levels. It is an important gain for oil producing countries and the global economy.

- Mohammed Al Asoomi is a spcialist on energy and Gulf economic affairs.