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The upside of a end to low oil prices

Although doubts persist that the deal will hold, Opec, the Organisation of Petroleum Exporting Countries, sent oil prices soaring past US$50 a barrel this week by agreeing to its first production cut in eight years. The group says it will trim output by 1.2 million barrels a day by January, thus limiting its daily production to 32.5 million barrels. While this amounts to no more than a 3 per cent cut, it is nevertheless significant because it ends two years of experiments with a free market for oil and required the assent of the three top oil producers - Saudi Arabia, Iran and Iraq. Just as important, Russia, which is not an Opec member, has also agreed to reduce its output.

The oil slump of the past two years has put money in the pockets of consumers but the moral of the tale is that one can have too much of a good thing. Persistently low prices could have bad consequences at a time when global trade is slowing. Many economies have suffered from oil price cuts. Opec members, who earned a record US$920 billion from oil sales just four years ago, are expected to earn just US$341 billion (S$487 billion) this year. The hurtful effects extend beyond producers. Singapore's rig makers like Keppel Corp and banks such as DBS Group have felt the impact of low oil prices too, as orders fall and loans to some clients sour. Elsewhere in Asia, remittance-dependent economies such as the Philippines and Bangladesh, and the southern Indian state of Kerala, have all been impacted by oil's decline because of layoffs in the Gulf states.

The output cuts seek to only trim the fat in oil production, which has exceeded demand by up to two million barrels a day for the past two years. The modest target reflects the desperation of Opec members to put a floor on prices. In Saudi Arabia, austerity measures have been introduced as reserves built up during oil's go-go days are depleted. Riyadh is itself partly responsible for the glut because it had depressed prices to stave off competition from United States shale oil which is costly to extract. That market intervention turned out to be a grim fable. Can the latest one work? That depends on Opec making the agreement stick.

While it may seem odd to welcome a firming of prices, given that most Asian nations are net oil importers, there are some reasons to seek a sustainable level. As long as oil prices do not soar overmuch - say beyond US$60 to US$70 a barrel - finance ministers generally think they can handle the impact on budgets. One key argument for higher oil prices is that these are an incentive for the world to aggressively pursue cheaper, cleaner energy. Further, it will persuade the auto industry to look away from gas guzzlers to fuel-efficient alternatives. Strategically, a return of US shale producers could cut the world's dependence on the roiling Middle East as the substantial oil supplier.

A version of this article appeared in the print edition of The Straits Times on December 10, 2016, with the headline 'The upside of a end to low oil prices'. Subscribe