Oil Prices Are Soaring After Saudi Arabia and Russia Reach a Deal

May 15, 2017

Crude oil prices surged over 3% to their highest level in two weeks after the world's two biggest producers agreed in principle to extend a deal on output restraint through March of next year.

The Energy Ministers of Saudi Arabia and Russia said that they had "reached an understanding" that it is necessary to keep surplus crude off the market "until March 31, 2018," in order to stabilize a world oil market that is still oversupplied.

The statement, made on the sidelines of an economic summit in China, is an admission that the efforts of the world's biggest exporters to balance the world oil market by holding back 1.8 million barrels a day of crude have failed to end the current glut as quickly as they hoped. The Organization of Petroleum Exporting Countries, which produces around a third of the world's oil, and a group of non-OPEC countries led by Russia, had agreed in November to keep the cuts in place through June.

News of the deal six months ago had provided an immediate boost to prices, but the strategy contained the seeds of the plan's own downfall, because higher prices encouraged producers in the U.S., which isn't party to the deal, to raise their output and invest in new production. U.S. output has risen more than 10% since the middle of last year, and data released on Friday by oil services firm Baker Hughes showed that the number of active rigs across the country rose for the 17th week in a row.

Benchmark futures prices for U.S. crude rose 3.2% on the news to trade at $49.41 a barrel by 0800 Eastern Time, while shares in big shale oil and gas companies such as EOG Resources (eog) and Whiting Petroleum (wll) were also higher. The market reaction reflected how far the commitment went beyond market expectations: the consensus view over the weekend was that the output deal would be extended through the end of the year, while some market participants were also concerned that Saudi Arabia and Russia, the two biggest exporters, would abandon restraint completely rather than lose any more global market share to American producers.

Read: All Drill, No Pump: Oil Producers Are Leaving Thousands of U.S. Wells Unfinished

The declaration carried on the Russian Energy Ministry's website said that the existing deal had had "a significant positive influence" on the market, noting that global inventories of crude had fallen faster than their historical averages in the last five months. But that glosses over the fact that inventories in advanced economies are still higher this year than they have ever been in May, and only slowly returning to their historical range.

The ministers said that while they start from the assumption of rolling over the current deal, they also hoped that "a wider circle of countries outside the current group will see the benefit of this cooperation in bringing stability to oil markets, and will join the effort."

The declaration has no binding force. It will need to be confirmed at a meeting of OPEC ministers on May 25th in Vienna. However, with the world's two biggest producers now on board, an extension now seems a near certainty.

UPDATE: This story has been updated to include more market reaction.

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