What's going on?
The oil price jumped almost 10% on Wednesday to nearly $50/barrel after OPEC (a group consisting of 14 oil exporting nations) agreed to cut its production (remember, less supply generally means a higher price).
What does this mean?
Back in September, OPEC made a preliminary deal to cut production, saying it would come to formal terms at its late November meeting. At the time, the oil price hit a 15-month high. But investors became skeptical of a deal actually getting done. Even going into today’s meeting, many felt a deal was unlikely. But lo and behold, a deal (tweet this)! It’s noteworthy that Russia, which is not an OPEC member, also agreed to cut its production, albeit with some conditions.
Why should I care?
The bigger picture: US oil companies might be the biggest winners.
Many US oil companies break-even at about $50/barrel, so, if the oil price stays at its current level or moves higher as a result of this deal, it’s likely that US companies will increase their production. Essentially, US production could fill any gap left by OPEC (which could counteract the boost to the oil price caused by the OPEC deal).
For markets: Compliance is key to this deal being effective.
There are various reasons to be skeptical about this deal. For one, oil production has increased a lot this year, so a moderate cut now isn’t really a decrease compared to output levels earlier this year. Also, the world will remain oversupplied with oil, at least in the near-term. Nevertheless, a deal that limits output is important – as Wednesday’s oil price move shows. One major question will be whether the participants in the deal stick by their word, or whether they will cheat and not limit their output (as has happened in the past with OPEC deals).