Oil prices have hit their highest level in a year following the decision last week by production cartel OPEC to cut output.

We now explain five key issues concerning oil.

1. Expectations were low

The oil price reaction suggests there was considerable scepticism over production cartel OPEC’s ability to conclude a deal – so the end result was treated as somewhat of a surprise.

The 1.2m barrels of oil per day (bopd) cut agreed by OPEC’s 14 members has clearly been received well by the market.

Deutsche Bank comments: ‘The agreement is more bullish than market expectations in that first, the 33m bopd upper limit of the range has been omitted, leaving 32.5m bopd as the sole target level.’

The agreement is contingent on 600,000 bopd of production being cut by non-OPEC members with Russia and Oman expected to be the main contributors. Russia has already pledged to cut its output by 300,000 bopd.

2. OPEC still matters – just not as much as it did

The meeting on 30 November reminded the world that OPEC still has a major influence on the price of oil. The value of Brent crude oil surged more than 10% on the day.

Perhaps what most impressed the market was the ability of Saudi Arabia and Iran to put aside their enmity to secure a deal.

Cantor Fitzgerald analyst Sam Wahab says: ‘This agreement has truly changed the landscape for oil over the coming years, putting a floor of $50 a barrel under oil prices.’

However, investments banks such as Deutsche and Goldman Sachs have left their 2017 oil price forecasts unchanged, partly due to scepticism over the cartel’s ability to implement the cuts. Several members have a patchy track record when it comes to compliance with quotas.

OPEC may have lost the ability to quadruple the oil price as it did during the 1973/1974 embargo but it can probably provide a backstop to prices.

It should not be forgotten that oil’s descent from $100 per barrel was substantially accelerated by OPEC’s failure to act at a pivotal meeting in November 2014.

3. The Saudis have lost

The decision to keep pumping the black stuff despite a growing oil glut was driven by Saudi Arabia in what was widely perceived as an attempt to protect market share by driving US shale producers out of business. This production freeze is effectively an admission of failure.

The oil price collapse had three key effects on the US shale industry. At the margin companies did go bankrupt and larger firms initially scaled back production. Perhaps most importantly, production costs roughly halved thanks to improved efficiency.

According to consultancy Rystad Energy the breakeven cost per barrel to produce from the Bakken shale in North Dakota has fallen from $59.03 in 2014 to $29.44 in 2016.

These streamlined shale operators are now further boosted by the election of an energy-friendly administration to the White House.

President elect Donald Trump is on record as wanting to boost domestic production. To achieve his aim could require a reduction in red tape and the fast track development of key infrastructure.

4. Indebted companies and oil majors most exposed to oil price movements

The reaction of UK-listed oil companies to the surge in oil prices was relatively easy to predict.

Oil majors need higher oil prices if they are to fund their prized dividends from organic cash flow.

Indebted oil companies need higher prices to avoid bumping up against their lending covenants.

Shares in the sector understandably raced ahead on the OPEC news.

5. Oil price remains hard to predict

Oil and gas producers could be winning investments if you think the oil price will stay strong well into 2017.

Sadly predicting the oil price is always tricky. So many moving parts, of which OPEC is just one, influence its direction.

Among the factors you need to grasp are the direction of the US dollar, demand in emerging markets, geopolitical instability and production outages.

Companies exposed to the oil price are therefore likely to be extremely volatile.

For example, Tullow Oil (TLW) is up 87% year to date but has traded all the way down to 116p in late January and all the way up to 309.7p at the time of writing. (TS)

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