Opec is not dead. The record number of journalists who crowded to Vienna to report on its deliberations might have been ready to write obituaries. Instead, the organisation has come up with a complicated deal to cut production, which at first sight satisfies almost everyone.
The main features of the accord are as expected. Saudi Arabia, the UAE and Kuwait will bear the main burden of the 1.2 million barrel per day cuts, reducing production by 756,000 bpd against the baseline. Libya and Nigeria are exempt from limits.
Strikingly, Iraq, after raising numerous objections, has accepted production cuts, too. The difficult case, Iran, has been assigned a cut – but only from a theoretical pre-sanctions level. Its new quota is actually about 100,000 bpd above what it is producing today.
Saudi Arabia, as always the main Opec player, has succeeded in one major goal – a limit, in principle at least, on Iraq, which has not had a formal quota since 1998. Iraq’s huge and low-cost reserves and the efforts of international companies make it the main challenger to Riyadh within the organisation.
Saudi Arabia has, though, made a significant concession to its biggest political rival, Iran. This has been the price to be paid for getting any deal; the price, too, of the Saudis’ financial struggles. Iran probably cannot produce at its assigned level yet anyway, so it is effectively getting a free pass. On the other hand, its share of total Opec output, at 11.6 per cent, will still have only returned to the identical level of 2011, before stringent sanctions were imposed.
Oil prices rose more than 10 per cent on the news of the planned 4.6 per cent drop in production. But even with the planned Opec cuts, if non-Opec countries do not participate, supply will still exceed demand in the first half of next year and already bloated stocks will swell further.
The deal faces two challenges, one tactical, one strategic.
The tactical one is the question of compliance, which has always dogged Opec. The planned cut is quite modest, about 1.4 per cent of global production. If, as has so often been the case in the past, some countries cheat, the oil price gains will soon evaporate.
Indonesia, which only rejoined in January, has suspended its Opec membership, raising the question of why a net importer was allowed back. Small cuts demanded of countries such as Gabon seem purely token, impossible to police or distinguish from unavoidable variations in output.
If Libya or Nigeria can get their security situation under control, production will rise further, demanding further cuts from others or weakening prices. The current arrangement lasts for six months – bringing us to the summer next year, when Saudi Arabia’s domestic demand will be rising again and the country would normally look to boost output. If market conditions are not substantially improved, there will be more difficult discussions ahead.
The arrangement seems to be conditional on Russia cutting 300,000 bpd and other non-Opec countries another 300,000 bpd. If achieved, this would be a landmark achievement, widening Opec’s influence over the oil market to a level not seen since the late 1970s. But this has to be viewed with great scepticism – Moscow has sometimes offered cooperation with Opec but never followed through. Its own compliance here is conditioned on the Opec and other non-Opec peers doing their bit. The Opec and non-Opec states will meet in Doha on December 9.
Russia will have to coordinate output restrictions across several state and non-state companies, including the giant Rosneft, a sceptic on cuts. In freezing winter conditions, it will also have to manage the technical difficulties of shutting in production at ageing fields, which yield large amounts of water. It is not clear what level Russia will cut from – probably from its own elevated forecast for next year, meaning that, like Iran, it would be curbing theoretical and not actual output.
The existence of other non-Opec countries able and willing to make the sizeable production cut demanded of them is doubtful. Of those at the table, Azeri production is in decline anyway. Oman has made heroic efforts to get total output over 1 million bpd, and cuts threaten its shaky finances. Kazakhstan has just started up its massive Kashagan field and would hardly want to shut it down again. Mexico’s licensing rounds to attract international investment into its fields would be rendered pointless by hefty cuts.
The really big non-Opec producers – the US, China, Canada and Brazil – were not involved in talks and would never agree to restrict output anyway.
The strategic challenge is longer-term and more fundamental. Opec risks losing at the negotiating table what it has won on the battlefield. Low prices have caused a large decline in US shale oil production, though not as large or as rapid as Saudi Arabia hoped back in 2014.
If prices reach $60 or even $70 per barrel next year, as some analysts now expect, shale oil growth can be expected to resume. One year of expansion like that of 2012 or 2013 would wipe out all the effects of Opec’s cut, leaving it with lower market share and prices not much higher. This would be exacerbated if demand, too, slows as prices rise.
On the other hand, if Opec can skilfully manage the transition to modestly higher prices, it may be able to find the golden mean – where US output rises only modestly, short-term revenues improve and the organisation can maintain its share of a growing market.
Opec has demonstrated it can reach a deal, but not yet that it can deliver and sustain it. Production cuts offer lifeline to its financially weaker members. But the organisation has a difficult balancing act ahead: managing the market moderately, but keeping down its upstart competitors.
Robin Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis
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