assessments

Tempered Expectations After an Oil Output Agreement

4 MINS READFeb 16, 2016 | 18:25 GMT
Saudi Oil and Mineral Resources Minister Ali al-Naimi (C) speaks to the press ahead of a meeting on Feb. 16 in Doha, Qatar, with Qatari, Venezuelan, and Russian energy ministers that led to an agreement to freeze oil production at current levels.
(OLYA MORVAN/AFP/Getty Images)
Saudi Oil and Mineral Resources Minister Ali al-Naimi (C) speaks to the press ahead of a meeting on Feb. 16 in Doha, Qatar, with Qatari, Venezuelan, and Russian energy ministers that led to an agreement to freeze oil production at current levels.

Two weeks after Venezuelan Oil Minister Eulogio Del Pino visited Moscow and Riyadh hoping to persuade their governments to coordinate a cut in oil production, Russia, Saudi Arabia, Venezuela and Oman conditionally agreed Feb. 16 to freeze oil production at January levels if other producers promise to do the same. So far, Kuwait and Iraq have agreed to freeze their output levels as well. While not the cut that Del Pino had hoped for, the production freeze will add stability to a volatile market, which in the past week alone has seen prices fluctuate nearly 10 percent in one day.

The agreement will not significantly raise oil prices — at least not for a while. Saudi Arabia produced 10.2 million barrels per day in January, just shy of its 10.5 million bpd peak last summer. (The country typically produces more during the summer months to feed domestic cooling needs.) Before 2015, Saudi Arabia had not produced more than 10 million bpd in over three decades. Russian production, which in January was around 11.2 million bpd, is also at record levels and is just shy of its peak of 11.3 million bpd earlier in 2015. Realistically, both lack the ability to substantially increase production beyond their current levels anyway, limiting the impact of the latest deal on their output.

Moreover, a deal without freezes or actual cuts in production in countries that are raising output will not be effective. Iran, at this point, is still in the process of increasing production and reportedly just sent its first cargos to European markets since its nuclear deal went into effect. The Saudis and the Russians are heading to Tehran on Feb. 17 hoping to persuade Iran to follow their lead. Iran, while unlikely to agree to such a freeze, could be open to a plan whereby it increases output by a specified amount — one close to its output at its full capacity. Although Iran's goals of soon adding 500,000 bpd of production may be overly optimistic, any new volumes it adds will put downward pressure on oil prices. 

Also, while Baghdad has tentatively agreed to the deal, whether it will comply is another matter. Iraq has seen its production rise from 3.4 million bpd in January 2015 to about 4.4 million bpd in January 2016, largely because of the increase in output of southern fields and the Kurdistan Regional Government's (KRG's) independent export of oil outside of Baghdad's control. The KRG, which is strapped for cash, will likely continue to increase production and exports as a way to help dig itself out of its financial problems. 

Enforcing a weak agreement is equally problematic. In the past, whenever OPEC or non-OPEC members agreed to a production level, it was almost impossible to enforce because countries often exceeded their allotted amount. For now, most countries are essentially at maximum capacity, and there are unlikely to be compliance issues. However, such issues could arise if and when there is a broader agreement that includes supply cuts rather than just freezing high production. 

Still, the agreement does mean that Saudi Arabia and its core OPEC allies — the United Arab Emirates, Kuwait and Qatar — will likely be less aggressive in attempting to use market forces to drive out higher-cost energy producers and competitors. Even if some countries such as Iran do not agree to production freezes, they will likely maintain current production levels. In short, Saudi Arabia and its allies believe their strategy is working and that it is just a matter of time until the energy market corrects itself, possibly in 2017.

OPEC might then decline to bring production back up to full levels by taking oil fields offline for maintenance. For example, the United Arab Emirate's Abu Dhabi National Oil Company has announced that it will take 200,000 bpd from its Murban Bab field offline in April for maintenance. In addition, Kuwait and Saudi Arabia are negotiating to bring the jointly operated al-Khafji and Wafra fields back online. The fields, which have a capacity of around 500,000 bpd, have been offline since routine maintenance began in May 2015. They were never brought back online because of unresolved disputes over operational rights.

Saudi Arabia and its allies will likely use the time between now and the next OPEC meeting on June 2 to reassess their strategy and see how oil prices react. At that point, they may be more open to organizing a broad cut, particularly if prices continue to hover around $30 a barrel. 

Though many oil producers, especially Venezuela, had hoped that Russia, Saudi Arabia and others could agree to production cuts, their deal shows there is still no consensus on how to cut production. In the meantime, Saudi Arabia and its allies appear to be staying the course on keeping production high and waiting until lower prices drive out higher-cost producers, for now. Still, that strategy is, and will be, a slow and painful process. 

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