With crude oil prices dipping below $50 a barrel for the West Texas Intermediate benchmark on hedge fund short selling, although there was a later rally, market speculation is again turning to the levels of compliance and the odds on an extension of the OPEC-non OPEC oil output agreement reached last November in Vienna.
Saudi Arabia and Russia, the architects of an oil production cut that has stabilized prices, presented a united front on compliance just as rising US inventories have sparked doubts about the OPEC and non-OPEC deal. This is the catch 22 situation that the oil producers are facing, as higher oil prices invite more US oil production, with further cycles of potential cuts to prop up prices.
The figures for US oil production make for grim reading for OPEC. The US Energy Information Administration lifted its forecast for US crude oil output, which will average 9.21 million barrels a day in 2017, up from 8.98 million projected in February 2017. For 2018, US production will rise to an average 9.73 million barrels a day, up from 9.53 million barrels projected in February 2017, and it will exceed 10 million barrels a day in December 2018.
Is the energy market justified in panicking over oil producer’s agreement intentions? Since the OPEC and some of its rivals, including Russia, agreed to cut output in late 2016, oil prices have stabilized at around $50-$55 a barrel, up from $45-$50 a barrel before. With the market starting to believe the cuts were backfiring by reviving US oil production, Saudi Energy Minister Khalid Al-Falih and his Russian counterpart Alexander Novak offered a united front, and insisted the cuts will work.
“The market had low expectations, which we have exceeded by a large degree,” Al-Falih said about the compliance level. "We are definitely on the right track and are picking up speed in terms of delivery. “Novak, who personally negotiated the cuts with Al-Falih last year, said that compliance with the curbs would improve in the next three months and promised that Moscow would cut production further.
Russia has to date trimmed output by perhaps 118,000 bpd, or a little over a third of its target 300,000 bpd in cuts under the terms of the Vienna agreement. However, Novak reassured al-Falih that another 40,000 bpd in cuts was coming “soon” and that Russia will be fully compliant with the targeted 300,000 bpd in cuts by the May 25 OPEC ministerial meeting in Vienna.
The Iraqi oil minister and Mexico’s deputy energy minister, alongside the OPEC secretary general, repeated similar upbeat messages as these countries are lagging behind their cut commitments. Khalid Al-Falih, acknowledged that global crude inventories aren’t draining as quickly as he expected, opening the door for an extension of the production cuts into the second half of the year.
Under current circumstances, Saudi Arabia is highly likely to extend its 538,000 bpd of output cuts under the terms of the Vienna agreement when it comes up for review at the ministerial meeting in late MayDr. Mohamed Ramady
The potential rollover is a subtle yet significant shift from just six weeks ago, when the minister said that an extension probably wouldn’t be needed. Under current circumstances, Saudi Arabia is highly likely to extend its 538,000 bpd of output cuts under the terms of the Vienna agreement when it comes up for review at the ministerial meeting in late May.
That extension however, will be contingent on the non-OPEC producing countries, including Russia, and the other OPEC producers, bringing their compliance fully in line with the agreed output cuts by the time of the technical committee review in mid-May.
Once again all eyes are on the key oil producer Saudi Arabia and under what scenario would the Kingdom acquiesce to cut production further to keep prices stable and not slip below the psychological $ 50 barrier. The Saudis might be further willing to trim output below its current 9.8 million bpd, if needed, to ensure this does not happen, as OPEC seems to be eyeing a $55 average as the equilibrium price that should bring global supply and demand into balance some time in the second half of this year.
Deepening strategic alliance
Saudi confidence in oil prices stabilizing above the $50 floor is largely built on Riyadh’s deepening strategic alliance with Moscow on oil policy and on the Mideast regional developments. This is a relationship the Saudis have been methodically nurturing through all of last year when the emphasis moved from the futile freeze talks to actual production cuts, with OPEC taking the first step in the Algiers meeting in August.
The Russians made it clear then that any participation from their side, along with other non-OPEC countries, can only come about after concrete OPEC decisions were taken. Since December 2016, Russia is now no longer hanging back to see how OPEC manages its oil policy but is increasingly integrated into and leading OPEC oil policy alongside Saudi Arabia as the two key global oil powers.
Russia’s Novak, for instance, co-chairs with the Kuwaiti oil minister Essam Al-Marzouq, the OPEC-non OPEC compliance committee, which will next meet in Kuwait on March 26 to review the levels of compliance among the 26 participating oil producers through mid-March.
The next key meeting will be in the technical committee review of compliance levels in mid-May, followed by the full ministerial OPEC-non OPEC meeting in Vienna on May 25, when the November output agreement will be considered for another six-month extension.
The issue of Iran and how to accommodate it following its production cut exemption in December is also an important one for Saudi Arabia, in particular, and there is likelihood that Iran will at the May meeting accept an end to its exemption from the quota agreement and to cap its output at around its current levels of 3.6 million bpd. The Iranians have found it very difficult to push their output much beyond current levels.
What’s more, Tehran may feel more cooperative on a hard quota cap by the time of the May 25 meeting because Washington under President Donald Trump, may re-impose or continue to threaten to re-impose US sanctions, which could make it even more difficult for Tehran to find the investment and technology to boost its oil field output.
Despite the implied threat of a return to the November 2014 market share strategy if the other OPEC and non-OPEC oil producers fail to comply with their promised output cuts, the Saudis are in fact limited by how much they can endure a bout of oil market instability, much less another collapse in oil prices.
While Riyadh is not hurting as much as other oil producers, it still needs to maximize its crude oil revenues while its undergoes the dramatic economic transformation that entails among other changes a shift to new state revenue through investment income and other sources of non-crude oil revenue like petrochemical sales.
Another critical driver to the Saudi oil policy to keep oil prices reasonably stable and above $50 and around that $55 equilibrium price benchmark is to provide the ideal financial and economic backdrop to its on-going bond issues and its eventual partial IPO of Saudi Aramco.
While there are limits to output cuts much below the current 9.8 million bpd in output, there may be room for further output cuts through lower domestic energy demand due to subsidy cuts and demand rationalization.
In the final analysis, for a renewal to take place, it is imperative that all sides comply with their commitments, as Minister Falih pointed out that “it is unfair for Saudi Arabia to bear all the burden and have free riders gain from the current agreement”.
This should indeed focus the minds of all the production cut participants, for without Saudi Arabia, the pact cannot survive.
Dr. Mohamed Ramady is an energy economist and geo-political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia.