OPEC’s decision taken at their informal meeting in Algiers, Algeria, resulting in a provisional production cut agreement, to be formalized in November, has stirred not only the oil market but also non-OPEC producers. Developments are following each other up at a pace not seen for a long time. Algeria’s Minister of Eneregy Nouredine Bouterfa, who also organized the informal meeting last week, has stated that OPEC and non-OPEC oil producers have plans for another informal meeting in Istanbul Oct. 8-13 to discuss how to implement a production deal. The latter can be seen as a Doha 2.0 approach, as major Non-OPEC producer Russia will be taking part also. At the Doha Meeting in in April 2016 both sides however didn’t reach an agreement, mainly due to adversary between Iran and Saudi Arabia.
The Algerian official also has stated to the press that the Algiers deal to cut output would be in force for up to a year. Iranian OPEC backer Venezuela has also stated that Russia will join the discussion in Istanbul. At the 23rd World Energy Congress in Istanbul, leading OPEC producers Saudi Arabia, Algeria, Gabon, Qatar and the United Arab Emirates will be present. Venezuela said that Russia’s Minister of Energy Alexander Novak also will attend. Based on sources in Algeria and Venezuela, all parties would be willing to discuss a production cut volume of around 1.2 million bpd in total.
The oil market again has been surprised by OPEC. The international oil cartel, against all odds, decided that it will cut its production volumes from 2017 onwards. OPEC members hase come to an agreement that they will keep to an production quota of 32.5 – 33 million bpd. The latter, when looking at current volumes, still would mean that there will be slightly more oil in the market than currently is the case.
The oil market has been in a flux the last days. However, first negative assessments by leading financial analysts have not materialized at all. Oil prices have been very firm, showing an upward price movement which is not over yet. A real deal could lead in November to a possible additional price increase of
The Algeria deal has been a surprise, as all signs were on red, no agreement was expected after that Iran reiterated before that they would not be interested in cuts or fixed quota as long as they are not reaching pre-sanctions production levels. At same time Saudi Arabia was also putting its foot down, requesting full support of OPEC members, including Iran. Somewhere behind closed doors diplomats have however been reaching a deal, in which Saudi Arabia and Iran could be a partner in. The total deal still has to be set in stone, and many hickups are still to be removed. It is to be expected that in November, Iran and Venezuela are going to be confronted by some sort of production caps, while possibly Nigeria and Libya will be given some additional room for production increase. If this is being agreed upon, OPEC leaders such as Saudi Arabia, UAE and Kuwait could be confronted by production cuts. No real deals at present have been made, OPEC only has agreed to come to an agreement in November, leaving still room for a new crisis or a total surprise.
The coming weeks OPEC watchers will have to look at two main issues, market fundamentals and geopolitics. As always the latter could be a deal breaker, as there are more geopolitical differences between OPEC members than currently is the case within the on life-support European Union. Saudi Arabia, supported by its GCC Arab compatriots, is still on a confrontation course with the Iran-led coalition (Iraq, Venezuela, Ecuador). Doubts about a possible full success in November are still large.
Positivism however at present should be having the overhand. If no OPEC deal would have been on the table, the market would have totally gone for the short approach. Oil prices could have been heading, based on irrational feelings largely, to levels below the per barrel or lower. Still, OPEC’s evening surprise has blocked this for the short term. The willingness to meet up with Non-OPEC producers the next days in Istanbul shows support for a stabilization of the global oil market. The need is clear, OPEC and non-OPEC at present are feeling the negative impact of low oil prices increasingly. The Saudi-Iran confrontation, supported by the need to quell non-OPEC production, has become very costly, partly even destabilizing parts of the world due to low revenues.
A major positive message has come out of the IEF 2016 meeting in Algiers. Saudi Arabia, seen as the main proponent of OPEC’s current strategy for market share, has indicated that it is willing to reach an agreement with Iran, without taking an uncompromising position in the latter. As Khalid Al Falih, Saudi Energy Minister, even openly stated before the behind closed doors meeting of OPEC, Saudi Arabia will allow Iran, Venezuela and others, to produce “at maximum levels that make sense”. These levels will be taken into account at the next regular OPEC meeting. The latest developments, leading to a possible OPEC-non OPEC meeting in Istanbul, could however speed the total process up.
For the MENA producers the (perceived) softening of the Saudi market position is however of immense importance. Al Falih’s statement shows a major strategy change of Saudi Arabia, as it gives an opening to reach a full agreement with Iran the coming weeks. The last couple of months it has been proven detrimental to OPEC to have two opposite parties on the table, while the whole oil (and gas) market is in flux and waiting for leadership from the oil cartel members. OPEC’s current initial agreement is totally due to the offered hand by Saudi Arabia to Iran. The outcome however is still not clear, the impact of the current Sunni-Shia confrontation in the Middle East (Syria, Iraq, Yemen, Bahrain) should not be underestimated at all. This religious-military confrontation for hegemony in the Middle East is part of the OPEC conundrum. Despite Saudi Arabia’s strong political-economic influence, Iran seems to be winning the current war for market share, while Saudi Arabia and its compatriots are being battered.
When looking at the official financial situation of the Kingdom, the picture is very bleak. Due to low oil prices, and high government expenditure, Saudi Arabia has been forced to use part of its international investment holdings and Sovereign Wealth Fund stakes to cover budget overruns. At the same time, Riyadh has acted very prudent and quick by ordering the end of a long list of subsidies (fuel, electricity) and put around billion of projects on hold. Even the Saudi Vision 2030 and a possible Saudi Aramco IPO will not totally remove the pain. The Kingdom also needs to keep revenues at a certain level to counter the costs of the Saudi-UAE led military intervention in Yemen, while supporting opposition forces in Syria and financing the new Egyptian regime. The latter goes for Saudi supporters, mainly Qatar, Bahrain, Kuwait and the UAE. All Gulf Arab countries have been hit hard by the negative effects of the OPEC market share strategy instigated by Saudi Arabia.
Iran’s position is also in flux. After a long period of being the outcast, Tehran has returned to international fora. Iranian officials are flocking the hotels and government buildings of European and Asian countries, offering large investment opportunities for the coming decades. Even that Iran is attractive, due to oil and gas, low oil prices are constraining the overall incentives largely. The appetite of IOCs and independents to enter Iran is lower than expected. Iran should start to be more flexible, as inside OPEC support for Iran’s hardline stance is eroding. Long-time supporters Venezuela, Ecuador, Gabon and Algeria, openly have asked for production cuts, as their economies are almost at a standstill.
Taken all the above, it is to be expected that in the next weeks OPEC officials will be putting an increased effort on bringing Iran and Saudi Arabia (behind closed doors) to put a real agreement in place, as OPEC members can’t continue at the current pace. The Istanbul Meeting next week can be seen as a step forward already. OPEC also will have to consider their options to stabilize the market in a way that there is no new incentives for non-OPEC producers to revamp their own production schemes. Shale oil (US) and Russia are not on their knees yet. Even that they are hanging as Apollo Creed in the ropes, as Saudi Arabia is playing Rocky Balboa, a total production cut, of around 1-1.5 million bpd, would only increase their own options to keep producing.
The first positive results for US shale producers already are clear. A significant amount of US shale producers have used the post-OPEC Algiers rally to hedge their price risks for 2017. Financial analysts already have stated that OPEC had thrown a “lifeline” to U.S. shale firms. Hedges have been made using the West Texas Intermediate 2017 calendar strip, an average of future prices next year that’s often used as a reference for hedging activity, which has increased to above per barrel. In May 2016 the same happened when US shale producers hedged their production also. U.S. independent oil companies have only hedged 16% of their price exposure for 2017, compared with 39% for the rest of this year, according to Houston-based boutique investment bank Tudor, Pickering, Holt & Co.
When looking at market fundamentals, there is definitely room to be BULLISH. Several major fundamental issues will be playing an increased role. Optimism about Libya and Nigeria seems to be built on loose sand. Libya is again heading towards implosion, while Niger Delta is still critical. In Norway strikes are imminent in the oil sector, cutting production for long time. Capital spending of Petrobras Brazil will have its effect, while US inventories are also heading towards lower levels. EIA’s optimism about production improvements and higher production still depend on the willingness to finance projects. China’s oil production is much lower than anticipated, while Venezuela is heading for a total shutdown. India also announced to increase its overall strategic petroleum reserves in next months. For OPEC is still time to take the long approach, it hurts everywhere, now it is time to play bluff poker and look who will blink first.
At the same time, OPEC’s future, especially when looking at Saudi Arabia, could be hit by another major issue (not related to oil in principal). The growing financial risks exposure of Saudi Arabia has increased substantially, largely by the US Congress vote to override President Obama’s veto of the JASTA (9/11)) bill. This could be playing an additional role in the current flexible approach of Saudi Arabia towards OPEC and non-OPEC member positions too. (for more info, look here and also here.