OPEC Deals and Petro Currencies

OPEC members have a preliminary agreement to cut oil production with the aim to support oil prices and pump up oil producer profits. We have a quick look at this to wrap our head around it...

Producers and exporters
In the end what matters is global production. Even if the USA does not export much, if US domestic production increases, they import less, which means more oil is available globally.

The 10 biggest oil producers in the world are, from most to least:

1. Saudi Arabia
2. USA
3. Russia
4. China
5. Canada
6. United Arab Emirates
7. Iran
8. Iraq
9. Brazil
10. Mexico

Now not all these producers actually export a lot... So here are the 10 biggest exporters, from most to least:

1. Saudi Arabia
2. Russia
3. Iraq
4. United Arab Emirates
5. Canada
6. Nigeria
7. Kuwait
8. Angola
9. Venezuela
10. Kazakhstan

Note that these data will soon add Iran as a major exporter, because there have been bans on Iranian oil and this list does not take into account the opening to Iranian oil.

Of these countries, these are the members of OPEC:

1. Saudi Arabia
2. Iran
3. Iraq
4. United Arab Emirates
5. Venezuela
6. Nigeria
7. Angola
8. Kuwait

Note that Russia is not in this marvelous list of open democracies of OPEC (ahem!). Note that Canada and the USA are also not there.

Trust, coordination, and actual impact
OPEC now produces about 40% of world oil. Non-members will have incentives to produce more if prices edge higher, which in itself limits the viability of such deals. But the issue is deeper... Suppose you, me, and 8 other people strike a deal to cut production to increase the world price of oil (with the objective of boosting oil income for all of us). If we all respect the deal, it will work. BUT... I start thinking to myself "all the others are going to cut, which will hold prices high, so I am going to produce more to get more income"... and you think the same... and we all start increasing production... and the price of oil falls again! Now suppose I hold myself to my word, but I start thinking "those other producers are going to cheat and produce more and get all the profits, while I sit here with my honesty and I get no benefits... hmmmm... I think I'm going to go ahead and produce more."

If cheating were obserbable and there was the possibility to "punish" the cheater, then the deal could hold. But the issue is that these are independent states and it is hard to check... and there are a LOT of large non-members, notably Russia, Canada, China, and the USA.

In this context, with less-than-40% of global production and hard-to-keep production quotas within OPEC members, deals between OPEC members to limit production will have a speculative impact on petro currencies such as the CAD, but the effect will fade fast, as the market comes to the very same conclusions I am explaining here. It is the textbook case of "Suboptimal Nash Equilibrium" in strategic interactions, which we teach in intro Economics courses :)

What to expect
Until the details are known and the deal is official in November 2016, (in about 6 weeks), expect speculative ups and downs on WTI and the value of petro currencies... Once the deal is official, all will depend on the credibility of the deal. My 2 cents: do not bet on a massive rise of oil prices and do not bet on a big appreciation of petro currencies such as CAD for a prolonged period, but DO expect speculative swings based on rumors and hype, which are great for trading profits, but do not change the big picture. CAD has turned bullish due to this rumor, but the underlying fundamentals are intact, so CAD will be overvalued for a while, and could correct later, once all I have written here becomes clear... Unless the deal is really credible and the market believes it, but as I said, I have my doubts for the lasting effect of this deal. If you liked, show appreciation by liking and sharing. Cheers!

YourPersonalEconomist