Eternal Battle for Oil Market Share Continues:

Russia – Saudi Arabia agree to freeze production

16 Feb 2016 by Cyril Widdershoven

The coming months, news sites and analysts will continue their analysis on a possible production cut by OPEC. Saudi Arabia and its followers will be blamed for all that is going wrong in the market, not deciding to assess the real underlying factors and other culprits.

Non-OPEC is producing too much oil, as long as these volumes are not killed by low oil prices, high debt levels or outright bankruptcy, nothing will change. Still, for Saudi Arabia there is light at the end of the tunnel. First real trouble has popped up at major oil companies worldwide, shareholders are not anymore convinced that their investments are safe and will yield the expected results.

Low investments, production cuts and deferred projects, will bring demand and supply closer to each other. Don’t expect OPEC leaders to put an end to the current battle, it will be up to others to take the pain and leave the market. A production freeze in the end is a continuation of the current situation. Saudi Arabia’s strategy is set in stone, and it will keep to it.

Note: Maybe it is time to assess another battleground very soon. The role of natural gas and LNG is under pressure, blood could be on the wall very soon, as Qatar-Australia-US-Russia will have to fight for market-share and price too. New markets still exist, but have not been explored at all by major players.

The oil market is again reacting as a chicken without a head. Rumors about a possible OPEC – non-OPEC agreement to cut production have been hitting media headlines the last couple of days. The ‘secret’ meeting in Doha, Qatar, between some of the major players in the ongoing battle for dominance on the global market, was presented as a water-shed. Investors were already preparing for new times, rising oil prices and possibly an unprecedented agreement between the main adversaries, OPEC’s stalwart Saudi Arabia and non-OPEC leader Russia, would lead to higher profit margins and possibly less bloodshed for IOCs and independents.

The latter statements were and are not based on any real assessment of the current oil market. Geopolitics, global economics and outright power plays, have overtaken market fundamentals at present. The current so-called oil glut, which is an exaggeration out of the books of story tellers such as Grim and Christian Andersen, is not the main reason for the overall desperate situation for most oil (and gas) companies at present. The effects of the Shale Revolution, low interest rates (aka high investments), growth of non-OPEC oil production and the unwillingness of OPEC to bend over to international pressure, are causing the current instable situation. Low oil prices, which normally would have led to a much stronger upwards reaction, are currently still on the mind of most analysts, politicians and oil workers. Years ago, the world would have been applauding when OPEC countries would have left oil prices at current levels, but the current global economic cycles, China’s depressed economy (and potentially heading for a real crisis), the ongoing wars in the Middle East and Russia’s growing aggressive military position, people are now yearning for higher oil prices and more stability

As once an energy expert stated “there are NO high oil prices … the economy will get used to it”. Low oil prices, in stark contrast to historical analysis and beliefs, have more negative impact than high oil prices. Don’t forget, the 2007-2008 financial crisis was not caused by high oil prices but by illegal and non-transparent financial instruments of banks and financial advisors. Economic growth was still there when oil prices hit the US per barrel mark.

So, why is the world now obsessed with a possible oil production agreement between Saudi Arabia and Russia, supported by some other obscure smaller producers? Why don’t analysists accept that the current Saudi-GCC oil production strategy is going to stay in place? There is no real incentive for OPEC producers such as Saudi Arabia, UAE or Qatar, to cut production at price levels of around US per barrel. If there is any positive effect on oil prices, others will for sure take over the space left by these oil producers. Saudi Arabia has been very open about its intentions. Since the start of the current oil price war, Saudi Arabia, and others such as UAE, Kuwait and even Qatar, have bluntly stated that they will not bulge for external pressure. The GCC faction within OPEC is only targeting a stabilization of their own market share or even, if all goes well, to increase their market share, which was partly lost to shale producers in the USA and other non-OPEC countries

The battle will continue, as the Arab producers, even that their financial reserves are being hit hard, will not change the direction they have taken some 1.5-2 years ago. The need for OPEC producers to quell the threat of non-OPEC and new upcoming entities (such as renewables) is still there. The market also is not yet fully taking into account that most privately owned oil and gas companies are currently facing debt positions that are not any more bearable. The majority of oil producers, even the likes of Shell, BP or Exxon, are feeling the heat of the banks already. Debt levels have increased to the point that some IOCs and independents will have to decide in 2016 to change their historical position on dividends. If this will hit the stock markets, share prices will fall tremendously.

Taking another position is even more valuable. The fact that Saudi Arabia, and its supporters UAE, Qatar and Kuwait, have been willing to discuss a production change with their opponents should not be taken as a first sign of a weakening position by the Arabs with regards to market share and production volumes. It should be seen as the first real sign that non-OPEC is on its knees. If the meeting would have been in in France, the Guillotine is already being erected in front of the Bastille. Non-OPEC members need to watch that their heads are not going to be chopped off next time they meet.

The current agreement is just another sign to the market that Saudi Arabia is willing to stabilize the market. Improvements will be made, but no time-line has been given by Saudi Oil Minister Ali Al Naimi. Russian minister of Energy Alexander Novak’s position was clear, Russia needs a stable market environment and higher prices very soon. Novak has not been given any of this, as Saudi Arabia has kept to its position. To take a unilateral decision to cut production would mean a very big challenge and risk for Russia at present. Analysts have also stated that Russia could be facing numerous technical issues if Russia would decide to cut production at present. A production cut or reduction of the flow could not only damage the fields or pipelines but also will force Moscow to set up expensive storage facilities. The latter situation could be the basis of the current production freeze agreement. Several Russian companies, such as Rosneft, even indicated before that no producer would currently be willing to cut output. If however, Moscow will force a cut, producing companies, especially in Siberia, would be facing technical challenges and possibly damage beyond repair. If for example oil flow is stopped in Siberian oil pipelines, they will freeze. Russian analysts even indicated that even that this will be going away in summer, there is still the risk of a long-term reduction in output. A reservoir can become polluted during this time. The only other solution is to cut production but storing the other volumes. Russia’s main problem is however it doesn’t have enough long-term storage. The existing capacity, owned by Transneft OAO , is already in full use.

At the same time, a bilateral agreement between Russia and Saudi Arabia at present has no real value also. Without the agreement of Saudi Arabia’s arch rival Iran, which is supported by Iraq, to commit itself also to production cuts (or freeze), OPEC will not take any chance. Tehran plans to boost its production within a year by 1 million bpd. The latter would mean not only a further growth of the oil glut but also a full conflict within OPEC on the cartel’s oil quota arrangements. If Tehran continues its plans, a new confrontation between Riyadh and Iran is not far away. Iraq’s current position is also of importance. Even that the country is an OPEC member, it does not need to commit to production quota’s since the Saddam Hussein period. An increased Iraqi production will only put more oil on the fire. In January 2016 Iraq’s output already reached 4.35 million bpd.