OPEC Inches Toward a Market Intervention

7 MINS READNov 22, 2016 | 15:05 GMT
A flame from a Saudi Aramco oil installation is seen near Khouris, Saudi Arabia. Riyadh is hoping to support an oil market recovery as much as possible ahead of an initial public offering of Saudi Aramco planned for 2018.
A flame from a Saudi Aramco oil installation is seen near Khouris, Saudi Arabia. Riyadh is hoping to support an oil market recovery as much as possible ahead of an initial public offering of Saudi Aramco planned for 2018.

Two years after Saudi Arabia and its Gulf allies rejected OPEC's attempt to intervene in oil markets to counter collapsing prices, Riyadh is rallying support for collective action. On Sept. 28, OPEC members tentatively agreed to cut production to between 32.5 million and 33.0 million barrels per day. However, output has continued to rise, meaning even deeper cuts will be required than before to reach that mark. The moment of truth will come Nov. 30 at OPEC's semiannual summit in Vienna, where member states will seek to finalize a deal on production cuts. Though Saudi Arabia has worked hard to convince other member states to support an agreement, the bloc remains divided over how much output to cut as a whole — and how much of the burden should be carried by each member. They are questions under debate this week, so as to finalize an agreement before the main event next week.

Iran and Iraq have emerged as the biggest obstacles to lowering output. Neither country is against the idea of an OPEC-wide deal in theory, but neither appears willing to sacrifice much of its own production in pursuit of one. As OPEC's second- and third-largest producers, respectively, Iran and Iraq's voices can hardly be ignored. Saudi Arabia's desire for a deal suggests that the bloc may concede to Iran and Iraq's demands. But the divisions within OPEC likely mean that any deal will be modest at most and will only lower the bloc's production to the levels seen just a few months ago. Oil prices will change little in response. Nevertheless, a deal does seem to be in the cards, even though it will likely cover only six months.

According to its latest monthly report, OPEC produced an estimated 33.64 million bpd in October — some 410,000 bpd more than in August — despite 160,000 to 200,000 bpd of Angolan production being taken offline for temporary maintenance issues. (Numbers based on secondary sources.) As a result, the cut needed to comply with the production limits agreed to in September has nearly doubled over the span of two months. Moreover, almost all of the output increase came from just two producers — Nigeria and Libya — that will be exempt from any final deal, meaning the burden of production cuts would fall entirely to OPEC's other member states.

This widening chasm has predictably strained the negotiations within OPEC on how to implement the September agreement. Among other challenges of bringing any deal to fruition is the opacity of data on production. For example, Iran and Iraq disagree with Saudi Arabia on which sets of data should be used in formulating a deal. OPEC reports cite both primary production figures — data reported by countries — and secondary oil figures, or data compiled by six external groups. Given the propensity of OPEC members to report inaccurate output data, Saudi Arabia has insisted on using only secondary data. But Iran and Iraq argue that such metrics underreport their actual output. In October, OPEC members reported nearly 1 million bpd of production more than what secondary sources reported. Iran and Iraq fear that if only secondary sources are considered, any freeze would be tantamount to a cut and any cut made will be deeper.

Iranian and Iraqi Reluctance

Iran and Iraq both argue that they should be exempt from any cuts or freezes, but neither Baghdad nor Tehran is seeking to shutter an OPEC deal altogether. On Nov. 20, Iraqi Oil Minister Jabbar al-Luaibi said his country would bring three different proposals to the talks in Vienna. And considering its ongoing financial woes, Baghdad needs oil prices to rise as much as any other major producer in the group. In July, Iraq finalized an agreement with the International Monetary Fund for a $5.4 billion loan package split into 13 tranches over three years (the first was received that month), and the government is expected to post a 14.1 percent fiscal deficit this year.

But Iraq argues that it should receive the same exemptions that Iran, Nigeria and Libya have already secured because it needs additional revenue to support its operations against the Islamic State. Baghdad says that, at most, it is willing to freeze its output at around 4.7 million bpd, but the significance of this pledge depends on which set of data one believes: This level of production is about 140,000 bpd higher than what secondary sources report, but 75,000 bpd lower than what Iraq itself claims it produces. The Iraqi government has spent the past two months trying to convince secondary sources of the accuracy of its reported figures, releasing field-by-field production data to support its claims, but the Kurdistan Regional Government disputes the data on oil produced in the autonomous region.

Iran, meanwhile, is focused on reaping the economic benefits of its 2015 nuclear deal with Western powers amid a season of heightened political sensitivities. Though any final deal would exempt Iran from cutting production, other OPEC members are still pushing the country to cap output at 3.92 million bpd — the level Tehran reported to OPEC in October. Tehran has long argued that it should be allowed to continue increasing output, since its oil industry is still recovering from the Western sanctions that were removed in January. In fact, Iran recently opened three new oil fields that are still ramping up production. Ahead of next year's elections, President Hassan Rouhani cannot be seen as "self-sanctioning" by bowing to international pressure to freeze oil production. Rouhani and Oil Minister Bijan Namdar Zangeneh are already fending off criticism from hard-line rivals over their moves to open the Iranian energy sector to Western oil companies and investment. Stifling Iranian production would carry extreme political risks.  

Saudi Goals

Nonetheless, it has become clear over the past few months that Saudi Arabia and its Gulf allies deeply desire some sort of deal — and the size of that deal may not be important. As it does every year, Saudi Arabia boosted production over the summer to meet higher seasonal demand, but it has yet to decrease output: Saudi production today remains around 400,000 bpd higher than during the first three months of 2016. Riyadh is hoping to use the surplus as a negotiating carrot to get other producers to shoulder a larger share of any agreement. At this point, Saudi Arabia and its Gulf allies could probably reduce production by more than 500,000 bpd without reducing their exports. If the OPEC deal falls through, Riyadh can then either dump its excess oil on the export market, stockpile it, or draw down its production anyway.

Riyadh is not currently focused on substantially increasing its market share. Rather, its main goal is to support an oil market recovery as much as possible ahead of an initial public offering of Saudi Arabian Oil Co. planned for 2018. While an OPEC deal may boost prices past $55 per barrel — the level where shale oil production becomes much more profitable — a lack of a deal would further suppress prices, especially if Saudi Arabia adds to the global supply glut, further hindering the market's recovery. 

Saudi Arabia appears to be throwing its weight into securing an OPEC deal. Riyadh — like all OPEC producers — is under no illusion that a substantial market recovery is in the offing, even if a bargain is struck in Vienna. Even so, the Saudis hope that a deal would limit the chances of another collapse in prices over the next 18 months and would establish a price floor based on current output levels. Such modest goals may be enough to persuade Saudi Arabia to overlook its squabbles with Iran and Iraq to secure a long-elusive OPEC deal.

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