To the surprise of many market watchers, OPEC has agreed to reduce its oil output to 32.5 million bpd from the current production levels of around 33.24 million bpd (roughly a 1.0 million bpd cut in production). OPEC members plan to set up a committee to decide over the next two months the individual supply cuts for each member country. So what exactly motivated Saudi Arabia to suddenly abandon its strategy of producing at record levels to weed out high cost producers around the world (i.e. U.S. shale producers). First and foremost, Saudi Arabia's economy has been suffering tremendously under the strain of low oil prices. Specifically, the country's foreign exchange reserves have fallen nearly 20% over the last two years, to $587 billion through March 2016. Saudi Arabia also recently said that it would cut ministers' pay by ~20% and pare perks for public sector employees, who make up two-thirds of the country's workforce. It is very evident that if Saudi Arabia continued down the path of keeping oil prices low, the country could have undoubtedly risked civil unrest as government services and perks continued to be cut.
Other interesting takeaway's from OPEC's decision to cut production, is that Saudi Arabia appears to be returning to a period of market management (i.e. controlling oil prices). Only a short time ago, market watchers had pronounced the death of OPEC, which now appears to be premature. Secondly, OPEC's decision to cut production also suggests that Saudi Arabia and Iran, with the mediation of Russia, Algeria and Qatar, were able to overcome the differences that derailed previous proposals. This likely suggests that we will now see better cooperation between OPEC members going forward. Overall, OPEC's decision to cut production (provided that member countries abide by their new quotas) is very positive for the oil markets, as well as energy companies globally.
While its interesting that OPEC's two largest producers, and regional adversaries, met in Vienna at OPEC headquarters prior to the meetings in Algiers, it would be optimistic to think that Saudi Arabia and Iran will agree on any type of production freeze. Recall, OPEC's last bid for a production freeze in April was subsequently derailed due to Iran not agreeing to participate, essentially reaffirming its rivalry with Saudi Arabia. On the positive side, these informal talks do signal that diplomatic efforts to secure a meaningful deal in Algiers are at least under way. Also, OPEC Secretary-General Mohammed Barkindo visited Qatar and Iran earlier in September to build consensus before the Algiers conference. Further, Russian President Vladimir Putin noted earlier in the month that the producers can overcome their divisions to reach a deal. Finally, Iran has now almost fully restored lost output to pre-sanction levels and may be more receptive to a production freeze. At the very least, these recent developments suggest that the overall environment in Algiers appears to be more conducive to reaching a deal than ever before.
While all of this sounds promising, the reality is a number of obstacles to securing an agreement still remain, most notably the tensions between Saudi Arabia and Iran as they continue to clash in proxy conflicts around the region from Syria to Yemen. Further, OPEC also remains locked in a contest for market share, both between members and with competitors outside the group (i.e. Russia and U.S. shale drillers), making a deal very difficult. So, while the Algiers meetings may look promising on the surface, most market watchers are likely not holding their collective breaths for any potential OPEC deal later this month.
The IEA recently released its monthly Oil Market Report, which pointed to a number of bearish signals that could dampen oil's recovery. Specifically, the IEA noted that global growth in crude oil demand will slow down faster than previously expected. The agency now sees growth at 1.3 million bpd for 2016, which represents a downward revision by 100,000 bpd from its previous estimate. Further, the IEA noted that demand growth will continue to decrease to 1.2 million bpd in 2017, citing a very uncertain macroeconomic environment. Exacerbating the demand side problem is OPEC nations (mainly Saudi Arabia, UAE and Kuwait) continuing to produce at record levels, which is increasing supply. Notably, the August daily average of OPEC was 930,000 bpd above last year’s (on an annual basis). Slightly offsetting increased OPEC production is a continual decline in non-OPEC production, with August output inching down by 300,000 bpd.
Overall, the IEA sees no chance of the market returning to a balance, predicting the glut will persist at least until June 2017. As with any oil market predictions, observers should take the IEA's latest doom and gloom report with a grain of salt. It's worth noting that over the years, the IEA has taken a lot of flak from critics with 20/20 hindsight about fairly large deviations between forecasted and actual numbers. Notably, prior IEA predictions suggest that the agency is unable to foresee events that deviate strongly from the norm such as peak conventional oil, rapid shifts in global trade flows and unexpected energy policy developments. So, when it comes to the IEA predicting oil demand and supply growth, market observers should exercise caution when relying on such predictions.
With Russia and Saudi Arabia recently announcing cooperation to stabilize world oil markets, one has to wonder whether this is simply just a head fake. The world’s top two crude-oil producers pledged to cooperate to stabilize global oil markets at the recent G20 meeting in China, however, neither nation agreed to a production freeze or provided any specific measures to bolster prices. Further, Saudi's oil minister Al-Falih later denied there was any current need to cap production, saying “markets are trending in the right direction.” Saudi's oil minister also previously stated that "supply and demand will come more or less into balance this year", suggesting that Saudi believes the oil market will right size itself without any OPEC intervention. If the past is any indication, OPEC members have previously talked of ambitious measures to stabilize the world oil markets, but have lacked any decisive follow-up actions. Further, a freeze proposal was derailed in April over Saudi Arabia’s insistence that Iran participate. The one positive take away from Russian-Saudi cooperation is that it suggests the two oil giants have a growing trust and understanding that collaboration is vital to oil’s recovery. Should the meetings in Algiers not yield a production freeze, both Russia and Saudi Arabia have stated that they plan to coordinate a bilateral working group on oil and gas cooperation in October and will meet at the OPEC ministerial summit in Vienna in November. Skepticism aside, time will tell whether this new and rare Russian-Saudi pledge to cooperate will yield any concrete actions to stabilize global oil markets.
A Canadian Energy expert