Saudi-Russian coordination instrumental in OPEC agreement

December 11, 2016

Beirut - Oil ministers of the Organ­isation of the Petroleum Exporting Countries (OPEC) surprised the markets by announcing an agreement that called for a 4.5% production cut that would decrease OPEC production 1.2 million barrels per day (bpd) to a target ceiling of 32.5 million bpd for the first six months of 2017.
The cuts may be renewed for an­other six months upon the agree­ment of the council of ministers in a meeting May 25th. Non-OPEC producers have also pledged to re­duce output by 600,000 bpd, lead­ing to a total production cut of 1.8 million bpd. Russia will lead the non-OPEC cuts with a 300,000-bpd reduction.
The cuts are projected to de­crease the record-level crude oil storage globally. Oil producers had marathon talks during the past few weeks. Saudi Arabia and Russia, the world’s two biggest oil produc­ers, played a pivotal role in ironing out the many differences among the producers.
The agreements’ modest achieve­ments are expected to establish a floor price of $50-$55 per barrel, a range that would assure produc­ing countries revenue increases of billions of dollars. A major driving force behind the agreement is the financial constraint experienced by those countries during the oil price crash of 2014-16. They want to avoid a third year of low oil prices. Many of them are worried about the political consequences of pro­longed budget constraints.
The floor price of $50-$55 per barrel is in the range of most of the producing countries’ oil price esti­mate in their budget projections. The projected floor price remains below the price range that would trigger a resurgence of US shale oil production, which costs approxi­mately $55-$75 a barrel to produce.
A $50-$55 per barrel Brent price would also stimulate investments in the upstream sector. There is much concern in the global oil in­dustry that a shortfall of invest­ments will result in an imbalanced supply and demand in global oil markets before the end of the dec­ade, leading to a resurgence in oil prices.
Markets reacted positively to the agreement, rising quickly about 10% to $50 per barrel. Observers continue to question the credibility of the agreement and how faithful­ly the countries will adhere to their pledges. Many questions have been raised about Russia’s commitment to its pledge. Some large Russian firms had announced that they plan to increase production in 2017.
A Russian energy source briefed on the discussions said: “President [Vladimir] Putin wants the deal… Russian companies will have to cut production.” The Russian economy is heavily dependent on oil rent. The price crash of 2014-16 caused many constraints in the Russian economy.
Russia and Saudi Arabia, the world’s two largest oil producers, cooperated closely to forge the agreement, succeeding to enlist support modifying the positions of the main producers (Saudi Arabia, Iran, Iraq and Russia).
Russia’s main role was to nego­tiate with rival OPEC producers, mediating differences that OPEC members could not reach on their own because of their rivalries. Pu­tin “played a crucial role in helping OPEC rivals Iran and Saudi Arabia set aside differences” to forge the agreement, Reuters reported.
Iran agreed to a modest increase in its allocation to 3.797 million bpd, compared to 3.75 million bpd and 3.78 million bpd during the past two consecutive months, in­stead of holding to its demands of a pre-sanction 4 million bpd pro­duction level and 12.7% of gross OPEC production. Saudi Arabia also agreed to take a cut of 486,000 bpd — the largest among OPEC states — and to be assigned a new allocation of 10.058 million bpd.
Iraq, the second largest OPEC producing country, accepted a cut of 210,000 bpd, the second largest reduction among OPEC states, to be allotted a production level of 4.351 million bpd. The Iraqi reduction was from the government produc­tion figures, as Baghdad had pro­tested the use of secondary sources (energy news agency and consult­ing houses figures) used as a refer­ence by OPEC.
The organisation, however, will continue using secondary sources as its main reference for produc­tion figures. OPEC established a committee of Kuwait, Algeria and Venezuela to review the monthly figures.
The encounter between OPEC and non-conventional oil is the first of many that are projected to flare up. Much will depend on the price level, whether it will move to record highs of more than $100 per barrel, as it did in the pre-2014 pe­riod, or even if it surpasses the $55- $75 per barrel cost range of non-conventional oil production. It will also depend on how low the cost of producing non-conventional oil can decline.
The 2014-16 price crash has driv­en home an important message to OPEC countries. They cannot any longer plan their budgets on re­cord-level prices, investing billions of dollars in white elephant pro­jects or endure massive corruption practices and huge unproductive employment in the public sector. Such practices carry heavy finan­cial burdens that low oil prices can­not sustain.
The main lesson of the recent oil price crash should drive home a second one to the producing coun­tries. It is necessary to diversify na­tional economies, stop reliance on oil rent alone and provide for the rise of several productive economic sectors such as agriculture, high-tech industries and tourism.