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Here’s Why Oil Prices Are Hitting an 18-Month High

Crude oil prices hit 18-month highs on Tuesday, the first trading day of 2017, buoyed by hopes that a deal between most of the world’s biggest producer countries to cut output, which kicked in on Sunday, will drain a global supply glut.

Prices for U.S. light crude oil hit an 18-month high of $55.24 a barrel, up $1.52, its highest since July 2015. Prices for the global benchmark blend Brent also jumped more than 2 percent to an 18-month high of $58.37, up $1.55 a barrel.

By 0730 Eastern time, U.S. futures had eased slightly to trade at $54.96 a barrel. Oil futures markets had been closed on Monday for New Year public holidays.

Jan. 1 marked the official start of a deal agreed by the Organization of the Petroleum Exporting Countries and other exporters such as Russia to reduce output by almost 1.8 million barrels a day.

“First signals suggest the…production cuts are raising hopes that the global oil oversupply will diminish,” said Hans van Cleef, senior energy economist at ABN AMRO Bank N.V. in Amsterdam.

Ric Spooner, chief market analyst at CMC Markets, agreed:

“Markets will be looking for anecdotal evidence for production cuts,” he said. “The most likely scenario is OPEC and non-OPEC member countries will be committed to the deal, especially in the early stages.”

Libya, one of two OPEC countries exempt from the output cuts, has increased its production to 685,000 barrels a day from around 600,000 in December, an official at the National Oil Corporation said on Sunday.

Non-OPEC Russia’s oil production in December remained unchanged at 11.21 million barrels a day, near a 30-year high. The country has promised to cut output by 300,000 barrels a day in the first half of 2017 in its contribution to the accord. The last time it made a similar commitment, back in 2001, it didn’t follow through. However, President Vladimir Putin has made a big point of supporting the current deal.

If Russian compliance, or non-compliance, is one risk to the deal, then an even bigger one is that U.S. producers will increase their own output to take advantage of higher prices. Data from oilfields services company Baker Hughes last week showed that the number of active drilling rigs in the U.S. hit 525 in the last week of 2016 – its highest level in a year.

That is still only one-third of the record level of 1,609 rigs at work in October 2014, but U.S. oil output has fallen by less than 1 million barrels a day from its 2015 peak. Analysts say that that suggests that the shale oil industry, which was the main target of the Saudi Arabia-led price war of the last two years, has broadly weathered the storm and greatly improved its efficiency as prices have fallen.