Could an OPEC deal mark the beginning of the end of cheap oil?

EXACTLY two years after Saudi Arabia coaxed its fellow OPEC members into letting market forces set the oil price, it has performed a nifty half-pirouette. On November 30th it led members of the oil producers' cartel in a pledge to remove 1.2m barrels a day (b/d) from global oil production, if non-OPEC countries such as Russia chip in with a further 600,000 b/d. That would amount to almost 2% of global production, far more than markets expected. It showed that OPEC is not dead yet.

The size of the proposed cut, the first since 2008, caused a surge in Brent oil prices to above $50 a barrel. Some speculators think it may mark the beginning of the end of a two-year glut in the world's oil markets, during which prices have fallen by half and producers such as Venezuela have come close to collapse. As long as prices continue to recover, Saudi Arabia can probably shrug off the fact that its previous strategy damaged OPEC at least as badly as non-members, and that this week's deal gave more breathing space to its arch-rival Iran than it would have liked.

The rally's continuation, however, depends on non-OPEC members such as Russia reliably committing to cut output at a meeting on December 9th. It also hinges on the speed at which American shale producers step up production, and on Donald Trump's dream of oil self-reliance.

Since the end of September, when OPEC sketched out a deal in Algiers to cut production, Saudi Arabia's oil minister, Khalid al-Falih (pictured), and his Iranian counterpart, Bijan Zanganeh, had engaged in a game of brinkmanship that at times seemed likely to doom this meeting. Oil prices have staged frenetic swings since then (see chart). Days before the Vienna gathering, some analysts gave it a mere 30% chance of success. The betting was that failure would push prices well below $40 a barrel, and possibly bring about the collapse of OPEC.

But Saudi Arabia, OPEC's biggest producer, realised that pragmatism was its best option. Its promised 4.6% cut in production is mirrored by many other OPEC members, though Iran was permitted a token increase as it recovers from nuclear-related sanctions. That may be galling for Saudi Arabia, but it is likely to benefit far more than Iran from the rise in oil prices, if sustained, than it will lose from lopping 486,000 b/d off its total output. It promises to cut to 10.05m b/d, which is not far below its level in the first quarter of 2016.

Moreover, the government's plans to modernise the economy and partly privatise Saudi Aramco, the state oil company, depend to some extent on higher oil prices, says Bhushan Bahree of IHS Markit, a consultancy. Counter-intuitively, he says that the kingdom needs higher oil revenues as "a bridge" to becoming a less oil-dependent economy. OPEC argues that a modest cut now will spur investment in new sources of crude that will prevent harmful oil shortages in the future.

The cuts take effect from January 1st and will last for six months. During that time, traders will monitor oil-tanker traffic to ascertain whether fewer are leaving port. They cannot monitor Russia's pledge to cut 300,000 b/d of production, because much of its production moves by pipeline, says Abhishek Deshpande of Natixis, a bank. But he believes that even so the agreement will start to cut global oil inventories next year. Non-OPEC output has fallen this year, adding impetus to the cartel's efforts.

Some speculators were bullish even before the deal. Pierre Andurand of Andurand Capital, a hedge fund, says the OPEC agreement could push oil above $60 a barrel within weeks. He notes that speculators were mostly betting on an OPEC failure, and that big oil consumers may need swiftly to protect themselves against rising prices. Airlines, for example, could scramble to hedge against soaring fuel costs.

If oil prices continue to rise, American shale producers will ramp up output, in effect capping the oil price. This may not happen as swiftly as some think. After all, there are suspicions that, to coax Wall Street investment, shale producers have exaggerated their ability to produce low-cost oil. But many of them are still standing, despite OPEC's best efforts to kill them off. The cartel cannot declare even Pyrrhic victory from the past two years.

Part (a)

The article starts as follows:

"EXACTLY two years after Saudi Arabia coaxed its fellow OPEC members into letting market forces set the oil price, it has performed a nifty half-pirouette. On November 30th it led members of the oil producers' cartel in a pledge to remove 1.2m barrels a day (b/d) from global oil production, if non-OPEC countries such as Russia chip in with a further 600,000 b/d. That would amount to almost 2% of global production, far more than markets expected. It showed that OPEC is not dead yet."

Discuss what happens to the global oil market under the two following scenarios:

Scenario 1: OPEC members let market forces set the oil price.

Scenario 2: OPEC members successfully coordinate their production to remove 1.2m barrels a day.

Part (b)

What is the measure that the article specifically mentions and that OPEC as an organisation needs to adopt to allow it to behave like a cartel? Please be elaborate in your explanations.

Part (c)

What is specifically the "pragmatism" by Saudi Arabia that is mentioned by the article? Do you think that it is smart, or it is not smart for Saudi Arabia to adopt this strategy of "pragmatism" toward other OPEC members or/and non-OPEC major oil producing countries in the context of global oil market as described in the article?