Production freeze agreement allows Riyadh to buy time

Friday 11/03/2016
Saudi and Foreign investors stand in front of the logo of Saudi state oil giant Aramco during the 10th Global Competitiveness Forum in the capital Riyadh, last Januray.

Washington - Following weeks of ru­mours and speculation that sent oil prices on a roller-coaster ride, sev­eral Organisation of the Petroleum Exporting Countries (OPEC) members cobbled together an agreement with the world’s largest independent producer aim­ing to halt falling prices and spark a price rally. The agreement, how­ever, fell short of market expecta­tions.

The agreement, reached among Russia and OPEC members Saudi Arabia, Qatar and Venezuela, calls for a “freeze” in oil production at January levels until June. The four architects of the deal agreed to meet again in mid-March. This news caused a temporary jump in prices that did not last long. In any event, there will not likely be much for them to discuss.

Russia produced a post-Soviet era high of around 10.9 million barrels per day (bpd) in January, according to the Russian Energy Ministry. The International Energy Agency (IEA) reported that in Janu­ary Saudi Arabia produced 10.2 million bpd, Venezuela 2.4 million bpd and Qatar 680,000 bpd.

OPEC members Kuwait and the United Arab Emirates quickly signed on to the agreement and independent producer Oman was expected to follow suit.

The dealmakers hope that the majority of OPEC members will go along with the output freeze, although Iran is not a party to the agreement. Tehran has refused to jeopardise its post-sanctions opportunities to boost produc­tion and exports. Also, there is no indication that sizeable non- OPEC producers will play along. Independent producers Brazil and Azerbaijan have made it clear they will not freeze output.

The accord is a compromise solu­tion at best, as Saudi Arabia has said it is not willing to cut production. According to Saudi Oil Minister Ali al-Naimi: “The reason we agreed to a potential freeze of production is simply the beginning of a process to assess in the next few months and decide whether we need other steps to stabilise the market.”

The agreement is in force until June, which gives Riyadh time to assess how compliant Russia and other chronic over-producers will be, the effect of extra Iranian oil on markets and how US shale produc­tion fares.

While putting a temporary floor under prices to prevent further de­cline, the freeze agreement does not address the current oversup­ply of 1 million bpd, let alone the oil in onshore or tanker storage. In fact, oil prices lost some upward momentum immediately after the Doha deal was made public when the US Department of Energy re­leased data showing American crude stockpiles at an 86-year high.

Ultimately, OPEC members Iran and Iraq could be stumbling blocks to the success of the freeze agree­ment. Post-sanction Tehran is ag­gressively trying to ratchet up its crude production and exports to pre-sanctions volumes. Iraq, de­spite ongoing internal strife, re­cently boosted its oil production to record levels of 4.1 million bpd and is desperate for revenue.

Iranian OPEC delegate Mehdi Asali was quoted in a domestic newspaper as saying: “Asking Iran to freeze its oil production level is illogical… when Iran was under sanctions, some countries raised their output and they caused the drop in oil prices.”

Iranian oil exports averaged 2.5 million bpd before sanctions re­duced the level to around 1.1 mil­lion bpd.

One of the biggest issues in pre­vious agreements between OPEC and independent producers has been compliance, with Russia re­peatedly failing to adhere to com­mitments. For this reason, Saudi Arabia will assess whether Moscow is serious about stabilising oil pric­es before negotiating an arguably more arduous process of getting numerous countries to collectively agree to reduce output. Another factor that the Saudis will be con­sidering is that US shale producers could benefit should a large price rise result from production cuts.

US shale oil output has been hit by sustained low oil prices, with production according to some estimates dropping as much as 640,000 bpd from the spring of 2015.

More telling, however, is that three major US shale oil firms — Continental Resources, Hess Cor­poration and Noble Energy — an­nounced at the end of January that they were slashing capital ex­penditures for 2016 by 40-66% as a result of $30-a-barrel oil prices. A substantial price increase could reverse some shale production de­cline but that is only likely to hap­pen when global demand rallies and there is a greatly reduced sup­ply overhang.

The freeze agreement allows Ri­yadh to buy time without having to make substantial changes to its production policy. The onus is on others to keep their end of the bar­gain and it gives Saudi Arabia until the scheduled June OPEC meet­ing to monitor Russia, Iran and US shale producers to see if oil market conditions improve.