Activity from Opec’s largest members reached a frenzy this week as the 22 June meeting heaves into view. All indications are that Opec and the 10 cooperating ‘non-Opec’ states will seek to loosen production restrictions later this month. But the devil is in the detail and with Opec’s statute requiring a unanimous decision for production increases there is plenty of room for any prospective agreement to collapse.
The current production restrictions have been in place since January 2017 and were extended to end-2018 during the last Opec+ meeting on 30 November (MEES, 1 December 2017). But the extension contained the proviso that “further adjustment actions will be considered based on prevailing market conditions” at the June meeting.
It’s clear then that Opec+ can agree on adjustments to the existing production limits to come into force before the end of the year. The question is whether there is sufficient will among the participants to come to such an agreement.
The dominant players within the Opec+ pact are Saudi Arabia and Russia and both appear to back loosening production restrictions. The two countries are by far the largest producers participating in the agreement and alongside the US are the only states with production capacity in excess of 10mn b/d.
Although Opec’s leadership continues to trumpet the organization’s importance and resilience, the key achievement they emphasize is securing a production agreement with Russia. This is effectively an acknowledgement that Opec by itself is unable to sufficiently influence the oil markets. If Russia walks away from the table then the agreement stands to collapse.
RUSSIA, SAUDI BROADLY ALIGNED
The Opec-Russia alliance is largely driven by the considerations of Russia and Saudi Arabia. For Russia, the largest benefit is that it affords a politically isolated Moscow a clear leadership role at a major international organization. Saudi Arabia meanwhile fears that cutting without Russian cooperation would see it lose market share to its rival and is also eying commercial opportunities outside of Opec’s sphere (MEES, 2 February).
So, what does each party desire now?
As the world’s largest oil exporter, Saudi Arabia is not opposed to oil price increases per se. But it is concerned that prices might dampen demand. And, arguably more importantly, Riyadh is seeking to improve ties with the Trump administration which is keen to ensure renewed sanctions on Iran won’t cause prices at the pump to shoot up. Saudi Arabia and its ally the UAE are therefore happy to put prices under (modest) pressure.
Meanwhile in Russia, President Vladimir Putin said in St Petersburg last week that $60/B suits Russia rather than the current high-$70s/B. Russia typically benefits less from oil price gains than other producers as these cause the ruble to strengthen against the dollar. Further oil price gains therefore risk benefitting rival producers such as the US, slowing demand growth, while not benefitting Russia.
Add into the mix growing Russian spare capacity, which US investment bank Citi puts at 410,000 b/d, and there is a clear incentive for Russia wanting to increase production.
If Russia is willing to wait until 2019 before boosting output, then life is easier for Riyadh. But if it wants to ease production limitations earlier, then Saudi Arabia will have to try to secure a unanimous agreement from Opec’s unwieldy membership.
TALKING PRICES DOWN
With that in mind, Saudi Arabia and the UAE have been acting to dampen recent price gains: Brent tested $80/B in May. Amid producers’ concerns that higher prices could slow demand growth (MEES, 18 May) a series of carefully choreographed statements pushed prices back towards $75/B, although they have edged back up in recent days.
A joint 17 May statement by Saudi Oil Minister Khalid al-Falih and Emirati counterpart Suhail al-Mazrouei emphasized that “recent market volatility” was down to “anxiety over geopolitical events despite the availability of ample supply.” On the same day a press release concerning Mr Falih’s conversation with his Indian counterpart Dharmendra Pradhan said Saudi and other producers will cooperate to “ensure availability of adequate supplies.”
The intended message of such statements is clear, despite OECD inventories now being below the five-year average, there is no supply shortage. But Opec+ is monitoring the situation and should one arise, it will increase production accordingly.
WHO CAN INCREASE?
Despite exaggerated reports of the extent of “overcompliance” to the production commitments, which largely stem from deliberately inconsistent arithmetic in Opec’s initial November 2016 agreement, Opec and its partners have indeed taken considerable volumes off the market (MEES, 2 December 2016). Opec in April produced around 120,000 b/d more than its recalibrated target of 31.92mn b/d (MEES, 11 May) – originally 32.5mn b/d prior to Indonesia’s suspension and Equatorial Guinea’s ascension.
This equates to a 1.08mn b/d cut from the agreed-upon baseline, although in reality Opec never cumulatively produced at that level in any single month. Add in cuts of 260,000 b/d from Russia, 300,000 b/d from Mexico, 30,000 b/d from Oman and then Kazakhstan’s 140,000 b/d increase and the Opec+ cut in April can be placed at around 1.5mn b/d.
Yet financial difficulties mean that the only producers realistically capable of adding sizeable volumes (in excess of 100,000 b/d) are Saudi Arabia, UAE, Kuwait and Russia. Within this, the latter are all close to (or exceeding) their production allocations and only Saudi Arabia has room to increase production within the terms of the current agreement.
VOLATILE MEETING LOOMING?
All four would likely be on board with easing production limits, with the possible exception of Kuwait. But they may still face opposition from other Opec members, as highlighted by this week’s letter from Iran’s Oil Minister Bijan Zanganeh to Mr Mazrouei, the 2018 holder of Opec’s rotating presidency. Mr Zanganeh lambasted unnamed members for speaking on behalf of the organization and reminded him of the Opec statute’s emphasis on “safeguarding the interests of member countries.”
Mr Zanganeh called for Opec to add to the 22 June agenda a discussion on supporting “member countries that are under illegal, unilateral and extraterritorial sanctions”.
Iran is seeking to prevent other members from increasing output and gaining market share at its expense in the likely eventuality that US sanctions force it to reduce production. But this appears to run counter to the statements of Secretary General Barkindo and other senior figures such as Mr Mazrouei who have repeatedly emphasized the group’s commitment to market stability.
Its latest Monthly Oil Market Report (MOMR) says “Opec, as always, stands ready to support oil market stability” but such action would seem to necessitate increasing output to compensate for Iranian falls.
This therefore brings up a dilemma for Saudi Arabia and any others who might want to loosen production restrictions early, given the requirement for a unanimous decision. Even if Riyadh is happy to wait until the agreement expires in end-2018 it will then want to implement a measured release of restrictions, which would again require an agreement.
This sets the scene for an intriguing dispute in Vienna. Expect Saudi Arabia and the UAE to be hyperactive in the coming weeks as they seek to secure the buy-in of as many Opec members as possible to their strategy to increase pressure on Iran.
First up is a 2 June meeting in Kuwait between Saudi Arabia, UAE, Kuwait and non-member Oman. As a traditional ally of Riyadh and Abu Dhabi, getting Kuwait onboard is vital for the pair. And despite not being an Opec member, Oman is an influential mediator as well as sitting on the Joint Ministerial Monitoring Committee (JMMC) which oversees adherence to the agreement.
