The big ripples from OPEC's production cuts

OPEC finally did it. On Wednesday, the oil cartel agreed to a production cut in an effort to bolster prices and relieve the fiscal pressure on member countries like Saudi Arabia, Iraq and Iran. This is a move first teased on Feb. 11, the day crude prices nearly touched the $26-a-barrel threshold, and has been a source of off-and-on headline volatility for months.

Although Riyadh will shoulder the bulk of the cuts and Indonesia “suspended” participation in the cartel ostensibly out of disagreement, the result is a strong show of relevancy for the organization that started the oil price war two years ago in a desperate effort to reclaim market share from U.S. shale producers.

Wall Street initially responded positively, pushing crude oil futures up more than 9 percent and sending stocks to new record highs, led by energy names like Exxon Mobil (XOM). But the ebullience faded amid nagging doubts about enforceability. 

Yet make no mistake: This agreement will have a major impact on everything from inflation to corporate earnings and consumer confidence.

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Here are the specifics: OPEC announced it will cap output at 32.5 million barrels per day (a 1.2 million barrel cut) in a six-month agreement that starts in January and could be extended another six months in May (chart above). The cartel is also seeking a 600,000 barrel per day (bpd) cut from non-OPEC producers, of which about half would come from Russia.

Iranian production will hold at 3.8 million bpd, a decrease from the 3.9 million bpd the Iranians were looking for but up slightly from recent levels. Saudi production will be cut nearly 500,000 bpd, representing the bulk of the reductions. Iraqi production will be dropped by 210,000 bpd.

Implementation could be a problem. Compliance with the cap will be monitored by a committee of Kuwait, Venezuela and Algeria along with two non-OPEC countries. It’s also unclear from what baseline number Russia’s 300,000 bpd cut will come and how quickly it will happen. Headline risk lingers as OPEC and non-OPEC producers plan to meet in early December to discuss the freeze agreement.

And finally, higher prices should over the medium term only encourage a further bounce-back in U.S. drilling rig activity -- putting the hard-fought market share gains OPEC earned over the last two years at risk.

The proof that the output freeze is real and not being absorbed by U.S producers will be revealed in the inventory data in the months to come. OPEC has a history of producing well over its officials output ceilings. And as Capital Economics noted, Russia reneged on an output cut deal in 2001.

For now, however, market dynamics and relief that OPEC members -- who don’t exactly like each other amid regional strife and religious differences -- could agree on something should push energy prices higher.

For the U.S. economy, the impact will be mixed.

Higher energy prices will boost corporate earnings in the energy sector, with the two-year profits recession ending in the third quarter for S&P 500 companies, thanks largely to a rebound in oil price since the beginning of the year. 

But higher pump prices will hit American consumers in the midst of the holiday shopping season while also putting upward pressure on inflation, potentially encouraging a more aggressive pace of rate hike from the Federal Reserve.

PNC Chief Economist Stuart Hoffman is now penciling another Fed rate hike in June following a likely increase on Dec. 14.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.