Oil Producers seek to Strengthen Industry Profits
Two major events have significantly influenced the foreign exchange market these last two months. First is the election of Donald Trump as President of the United States, which strengthened the US dollar (USD) because of the expectation that the next administration will promote industry and manufacturing growth within the country. Secondly, the joint decision by a significant amount of major petroleum producing countries to decrease aggregate supply during the first half of 2017 has strengthened the national currencies of oil producing countries. For example, over the last two weeks the Colombian Peso has gone from an average above 3.100 against the USD to approximately 2.990 this week. Even though this variation is not monumental, it is closely tied to the price increase in the oil industry, upon which the Colombian economy is very dependent.
Oil Producers seek to Strengthen Industry Profits
Throughout 2016, the Organization of Petroleum Exporting Countries (OPEC) as well as major oil producers around the world, such as Russia, have sustained several rounds of dialogue. The last two weeks, however, have represented a turning point within these rounds of discussions because they mark the formalization of an agreement to reduce global petroleum output. First during the 171st OPEC meeting, held on November 30 at the organization’s headquarters, the member countries reached the “Vienna Agreement”. The “Vienna Agreement” only engages OPEC member countries and effectively reduces the organization’s petroleum output by 1.2 million barrels per day (bpd) to 32.5 million bpd as of January 1, 2017.
Afterwards, on December 10, a second meeting took place in Vienna with non-OPEC oil producers, notably Azerbaijan, Bahrain, Brunei, Equatorial Guinea, Kazakhstan, Malaysia, Mexico, Oman, Russia, Sudan, and South Sudan. During this high-level meeting chaired by the OPEC President alongside the Russian Minister of Energy, the eleven non-OPEC oil producers agreed to reduce their joint oil production by 558.000 bpd. The largest contributors to the reduction include Russia with a cutback of 300.000 bpd, Mexico with a 100.000 bpd reduction, Oman cutting back 40.000 bpd, and Azerbaijan reducing its production by 35.000 bpd. In total, the agreed upon reductions account for almost 2 million bpd and have led to a severe spike in oil prices from around US$45 on November 29 to a high of approximately US$55 earlier this week.
Even though there is still speculation as to whether these multilateral deals will hold for the first six months of 2017 without any country breaking its engagement, the reality is that the markets, including the foreign exchange, is reacting to the official announcements. In fact, many of the key players, particularly Saudi Arabia, seem extremely committed to seeing the deal through in order to rebalance the petroleum market. In this regard, during a recent press conference, the Saudi Minister of Energy said that his country is willing to reduce production even below the agreed upon level if the market requires it.
The central weakness of the strategy behind the “Vienna Agreement” along with the commitment from non-OPEC nations is that competitors, notably the US, China, Canada, and Brazil, could fill the market void left behind by the reductions. As oil prices rise, more companies and energy sources that are not competitive at low prices will enter the market. Therefore, if the price elasticity of demand for oil is more inelastic than expected, then the countries that reduce production will end up losing market share to other suppliers because demand will not decrease significantly.