What the oil production cut means for all businesses

Higher crude prices are good news for everyone, at least for now
Effect of oil prices on business, Oil economy, Oil prices, Columns


If there was a way to end the year on a bright note for as many businesses as possible, a deal to cut oil production was probably the most likely news to hit the spot.

Of course, there will be some sectors not sharing in the joy – those that rely heavily on oil to fuel, such as aviation, manufacturing and agriculture, may be dreading increased costs. But that would be short-sighted. Especially for the Middle East, one of the biggest oil producing regions in the world.

If the oil price continues to rise, as it did in the weeks leading up to and after the deal between members of the Organisation of Petroleum Exporting Countries (OPEC) and Russia, to a 17-month high on December 14, economies in the region will be re-fuelled.
Banks will be restocked and able to loosen the purse strings to lend to new and growing companies. That, in turn, will have a flow-on effect to related businesses, while entrepreneurs should get a warmer welcome from their banker.

Governments will have more confidence to invest in public infrastructure, recharging, among other sectors, a construction industry suffering from not only a lack of new projects but changes that have cut, stalled or cancelled developments. The revival could eventually be sufficient to help firms such as Saudi Oger avoid bankruptcy.

Higher oil revenues also will help governments across the Gulf diversify the economy more quickly, helping to prevent a repeat of the sudden economic decline of the past two years.

In Saudi Arabia, higher oil prices also will fan investor interest in the part-privatisation of state oil giant Saudi Aramco, providing as much as $1 trillion to plug the budget deficit and spur economic diversification.

In summary, healthier state budgets will feed optimism in the broader economy. But let’s not be overly enthusiastic. While optimism and sentiment will strengthen, the proof will be in the pudding as attention now turns to compliance.

Given the damage to state revenues (plus sanctions in Russia), watching the oil price tick upwards should be sufficient motivation; Saudi Arabia has even hinted that it may cut production more than expected - although Capital Economics quickly questioned the likelihood.

The International Energy Agency said on December 13 that global oil markets would swing from surplus to deficit in the first half of 2017, based on the agreed production cut.

But there are also counter moves by the US shale industry, with rigs that were suspended when low oil prices made their operations unfeasible beginning to come back online at a faster pace. Some analysts suggest such moves will only ramp up as the price rises, adding more supply to the market and again putting pressure on prices.

Also, some producers that were not part of the deal, including Nigeria and Iran, will continue to raise output.

Iran’s output growth may be a sore point for Saudi Arabia, which led the original pledge two years ago to maintain supply levels in a war against shale when Iran was still under sanctions. In doing so, the kingdom’s economy has lost billions of dollars, its veteran oil and finance ministers has been removed and the kingdom has given perhaps more room for arch-rival Iran to increase output than it would have liked. But it has gained more from the deal than it would have lost by not agreeing to soak up about half of OPEC’s production cut.

At a time of year when markets consider the results of the past 12 months and forecasts for the next, the oil deal could prove to be the headstart that 2017 desperately needs.

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