Robin Mills: Few early benefits in oil cap for Saudi Arabia

Saudi Arabia may have lost nothing tangible by joining the accord to freeze oil production at January's levels, but its aura of petroleum invincibility has sprung a leak.

In diplomacy, as in life, it is pleasing to be rewarded for something you were going to do anyway. Last week's agreement between Saudi Arabia, Russia, Venezuela and Qatar to freeze oil production at January's levels, practically speaking, limits only the Saudis. So why would Riyadh acquiesce?

Qatar’s crude oil production is down by 200,000 barrels per day from its 2008 high. Venezuela’s output, quite steady since 2011, dipped sharply in January. Opec itself forecasts Russian oil production to fall a little this year. So of the four countries in the freeze, only Saudi Arabia is cap­able of growing much from its January level, and it will need more oil this summer to meet domestic demand, if it wants to keep exports steady.

Markets were unimpressed, prices rising sharply but then falling back as it became clear the deal offered just stabilisation at current high levels of output, not cuts. Implementation is contingent anyway on cooperation from other major Opec and non-Opec producers, and Brazil, Azerbaijan and Norway have all said they would not participate or that their output was going to fall.

The UAE energy minister Suh­ail Al Mazrouei said that a cap would have a positive effect, although the country’s oil production capacity is planned to grow by some half a million barrels per day this decade.

Kuwait, which said it was ready to join, would find it difficult to boost production much from current levels, particularly given the continuing shutdown of the shared Neutral Zone. Iran and Libya would like others to freeze, but not themselves. Iran itself plans to increase output by half a million barrels per day by its new year, on March 20, as it rebounds from sanctions. Libya could boost production significantly if its security situation improves.

Bringing Iran into the agreement would require accepting a production increase but limiting it in some way. Yet the Saudis would be reluctant to formally concede market share to a rival. And there is no way to know Iran’s true sustainable production level without testing it, which will take several months at least. If Tehran were to offer to curb its increase to, say, half a million barrels per day, Riyadh would always suspect that was the limit of Iranian capability.

So the current discussion gives more the impression of searching for an initial benchmark of trying to start a process that could eventually lead to comprehensive production cuts. Brokering the 1999 agreement between Opec and Mexico, Russia, Norway and Oman took almost a year of secret meetings in hotel rooms around the world.

The current price slump, unlike that of 1999, was not even triggered by Opec over-production, but by the dramatic growth of US shale oil. It is hard to avoid the impression that Opec’s resolution has cracked, the weaker members, particularly Venez­uela, proving the organisation’s Achilles heel.

US production has been falling since April last year, but not yet enough to rebalance the market. Talk of production freezes or cuts now emboldens US oil producers and their fin­anciers that better times may be around the corner, that it is worth trying to hold on for a few more months.

As the chief executive of Texas-based Pioneer Natural Resources told investors: “You’ve got to use events like that [the production freeze talks] to put hedges in the marketplace”. If prices recover somewhat, shale companies can lock in prices at a level sufficient to justify a return to drilling.

If the agreement eventually leads to a comprehensive accord on new production quotas, including both Russia and Iran, that would be an impressive diplomatic achievement. It would, though, rescue Opec’s high-cost competitors. The Saudis might think that a price worth paying for keeping the organ­isation together.

If, as is more likely, the discussions lead nowhere, or to a series of temporary and largely ineffective deals, Opec’s credibility will have suffered a major blow, and there would be nothing to prevent its members breaking ranks. Saudi Arabia may have lost nothing tangible by joining this accord, but its aura of petroleum invincibility has sprung a leak.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis.

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