OPEC agreed to a preliminary deal that will cut production for the first time in eight years. Oil prices gained more than 6 percent as Saudi Arabia and Iran surprised traders who expected a continuation of the pump-at-will policy the group adopted in 2014.

The group agreed to drop production to a range of 32.5 to 33 million barrels per day, said Iran’s Oil Minister Bijan Namdar Zanganeh, following a meeting in Algiers. While some members of OPEC will have to cut output, Iran won’t have to freeze production, he said. Many of the details remain to be worked out and the group won’t decide on targets for each country until its next meeting at the end of November.

The lower end of the production target equates to a nearly 750,000 barrels-a-day drop from what OPEC said it pumped in August.

The deal will reverberate beyond the Organization of Petroleum Exporting Countries. It will brighten the prospects for the energy industry, from giants like Exxon Mobil Corp. to small U.S. shale firms, and boost the economies of oil-rich countries such as Russia and Saudi Arabia. For consumers, however, it will mean higher prices at the pump.

"The cut is clearly bullish," said Mike Wittner, head of oil-market research at Societe Generale SA in New York. "What’s much more important is that the Saudis appear to be returning to a period of market management."

The agreement also signals a new phase in relations between Saudi Arabia and Iran, which have clashed on oil policy since 2014 and are backing opposite sides in civil wars in Syria and Yemen. The deal indicates that Riyadh and Tehran, with the mediation of Russia, Algeria and Qatar, were able to overcome the differences that sunk another proposal to cap production earlier this year.

Brent crude surged as much as 6.5 percent to $48.96 a barrel in London. The shares of Exxon Mobil, the world’s largest publicly listed oil company, climbed 4.2 percent, the biggest one-day increase since February.

David Fuller's view

This service has often mentioned that supply is the crucial factor for all commodities.  Supply can change dramatically, particularly for agricultural commodities.  For industrial resources such as crude oil, production cutbacks and supply breakdowns or strikes will firm prices.

In contrast, demand changes gradually, increasing somewhat when prices are low and declining when they are high.  GDP growth or weakness will also influence demand.

OPEC’s preliminary deal to cut production has surprised the market because the Saudis, having triggered production increases in 2H 2014 in an effort to close down US shale producers, were masochistically persisting with this policy which was not working.  All oil producers were losing revenue but that encouraged shale producers to refine their technology so that they could compete at lower prices. 

It remains to be seen whether Saudi Crown Prince Mohammad bin Salman will stick to today’s preliminary agreement to cut production slightly, or revert back to the lose-lose policy of maximum output and lower prices.  Even if the agreement holds, needs must will lead to some cheating.  If the agreement is scrapped, oil prices will fall back more sharply than they rose today. 

While the agreement holds, we can expect crude oil (weekly & daily) to move back into the $50 region.  Further cutbacks and/or other disruptions would be required to for crude oil to trade above $60.  However, higher oil prices will encourage further shale production, and not just from the USA.