OPEC Debates Oil Production Cut

23 November 2016 Andrew Manners, FDI Visiting Fellow

Background

Market watchers and policymakers will be closely observing next week’s OPEC meeting, with many hoping that the promises to cut production that were made by OPEC members in September, can be realised. An agreement would prove to be a game-changer in the near term, giving under pressure producers from Azerbaijan to Angola and the Gulf to Gabon a much-needed lifeline. After a relentless glut, a proposed OPEC deal to cut one million barrels daily (from roughly 34 million now) could send prices to around US$55 per barrel, as the oil market returns to some sort of equilibrium by mid-2017. Yet despite this, an agreement still appears elusive and several obstacles must be overcome if a deal is to be reached.

Comment

After months of failed talks, producers are bracing for a possible breakthrough, with officials hopeful that a deal can finally be struck. ‘It is likely everybody will be on board by the end of the day,’ Ibrahim Waya, a member of Nigeria’s delegation to OPEC, told reporters after a meeting at the cartel’s headquarters in Vienna on Tuesday. ‘Everybody knows the states are high,’ he added.

The 14-member group, which controls around one-third of global oil production, is trying to pin down details after a general pact to cut production was unexpectedly reached in September. Generally speaking, the broad terms of an agreement have already been reached: members will co-operate to cut roughly four per cent of their output each, with the agreement lasting six months from the start of 2017. OPEC has also said it wants other global producers, including Russia, to agree to a curb; a prospect that President Vladimir Putin has entertained.

Any cut would alter the oil market in near term. According to Goldman Sachs, even a cut of one million barrels could send prices over US$55 per barrel, with supply and demand balancing sometime in 2017, after heavy production (led by Saudi Arabia trying to crush US shale producers), and a slowdown in China saw oil prices plunge to below US$30 per barrel. That is still far shy of the US$115 per barrel that oil was trading for as recently as June 2014.

But for developing petro-states whose lifeblood remains black gold, including Angola, Venezuela, Nigeria, Ecuador, Brazil and Azerbaijan, the subsequent price uptick may help them to balance the books, restructure outstanding debts and ward off impending rescue packages; Azerbaijan, Nigeria and Angola have all flirted with IMF loans in recent months. Meanwhile, richer producers such as Saudi Arabia, Qatar and Kuwait, would not need to tap into their foreign reserves or cut subsidies so much. A moderate price surge would also buttress a resurgent US dollar, which will crimp oil prices somewhat if the US Federal Reserve raises rates next month.

An agreement is no sure thing, however, and differences must be resolved before pen can be put to paper. Both Iraq and Iran have disputed the baseline production figures which any cut will be based on. They have also questioned their own ability to cut their production right now and have raised the possibility of increases – Iraq because it needs oil revenues to fund its ongoing fight with ISIS, and Iran because it wants to regain its lost market share after sanctions were lifted earlier this year. Earlier in October, in fact, Tehran overtook Riyadh as India’s biggest oil supplier.

This ongoing rivalry could prove to be another stumbling block, too. Both states are vying for regional hegemony and, with Tehran seemingly scoring strategic successes over the Kingdom – in Syria, Iraq and Yemen – Saudi Arabia is loath to hand Iran a favourable deal, especially if it would mean that the Islamic Republic can better flex its muscles, funding its proxy wars in the region even more. Given this, both appear willing to walk away from a potential deal if it perceives the other as gaining a notable upper hand.

For now, the market remains torn on whether a deal can be reached. While a majority of analysts remain bullish, uncertainty saw oil prices pull back on the afternoon of 22 November, with Brent trading around US$49.10. While a deal would give the oil market a much-needed boost, OPEC talks have a long history of falling over at the last minute. Few would bet against it happening again. If the deal were to collapse, moreover, then producers, and especially Saudi Arabia, Russia, Iraq and Iran, would be left with no choice but to pump full-throttle in a global battle for market share.

That would dent prices in the near to medium term, despite a slight upsurge in demand, and heap even further pressure on almost everyone, be it Saudi Arabia, Iran, Iraq, Libya, Russia, the poorer petro-states in Africa and Latin America, and even besieged shale producers in the US.

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