Yemen’s fragile truce is being extended, but there is still a massive amount of work needed to bring the conflict to an end.
OPEC’s oil ministers and technical experts have been holding marathon consultations on the parameters for a production-cut agreement leading up to the ministerial council meeting on November 30 in Vienna, with optimism among the group building that a formal deal is now possible. In a significant shift from its market share strategy of the past two years, OPEC is hoping that a return to its traditional market management strategy of setting production targets will accelerate a rebalancing of oversupplied markets and help stabilize prices at higher levels in 2017. OPEC announced a surprise agreement to work toward setting production targets at its ministerial meeting in Algiers in late September but left details on how the group would implement a cut to be worked out by the time the group gathered at the end of November.
A series of meetings have taken place over the past six weeks but so far the gatherings have produced only a steady stream of rhetoric extolling the group’s optimism an agreement is in reach, with ministers arguing the financial imperative to agree on an accord means failure is not an option. With just over a week to go, few details have emerged on how OPEC will overcome the myriad complex demands being made by various member countries. Indeed, while the market is also increasingly convinced that OPEC will announce an agreement given the enormous pressure to do so after raising expectations, there is considerable concern that the final deal announced will lack credibility and transparency, which could lead to even lower prices. Futures prices for West Texas Intermediate (WTI) have averaged just above $45 per barrel (bbl) so far in November after oscillating in a wide, volatile range of $25-50/bbl this year. Failure by OPEC to reach a credible agreement could lead to oil prices falling back below $40/bbl, according to some traders.
The Devil is in the Details
OPEC is aiming to reach a deal that collectively lowers output to between 32.5 and 33 million barrels per day (mb/d) in an effort to hasten the rebalancing of oversupplied markets, but members have made the task more difficult by significantly increasing production ahead of the November 30 meeting. Saudi Arabia is pushing for a more substantial, lower target of 32.5 mb/d, which initially implied a relatively modest cut of 700,000 b/d (kb/d) but, since then, the group’s production has surged. The OPEC Secretariat’s latest Monthly Oil Market Report shows output in October jumped to 33.6 mb/d, an increase of 400 kb/d over August levels. As a result, a more substantial cut of at least 1.1 mb/d is now required to reach the preferred target level. The report publishes monthly production estimates based on averages of secondary sources rather than official data submitted by member countries due to a large discrepancy in some country’s data with public sources.
The International Energy Agency’s latest oil market report shows a slightly smaller increase in OPEC production of around 350 kb/d. However, the IEA cautioned that in addition to higher OPEC output, an upward revision to the forecast for non-OPEC supplies will lead to a higher than expected build in global oil inventories in the first half of 2017 and hence a further delay in a rebalancing of supply and demand levels.
Against this somewhat more challenging market outlook, OPEC ministers and technical experts are reportedly making progress on a number of issues raised in Algiers, including objections by Iran and Iraq over participating in any cuts. Some ministers met on the sidelines of a gas forum in Doha on November 17 and reportedly agreed to put forth a compromise proposal that Iran caps its production at 3.92 mb/d, higher than current output of around 3.7 mb/d, but below Tehran’s demand for a freeze at a higher 4-4.2 mb/d. Tehran has demanded that its production should constitute a historical 12.7 percent share of total OPEC production prior to international sanctions, or 4.13 mb/d of the proposed 32.5 mb/d output ceiling.
Iran’s argument is largely academic given that its production is not expected to reach even 4 mb/d next year. Saudi Arabia has argued that Iran’s production has peaked for the near term, and it should not be granted any major concessions. Iran’s OPEC governor, who attended the Doha talks, said following the meeting that he was optimistic that OPEC would reach a deal when it meets formally in Vienna. Iranian Oil Minister Bijan Namdar Zanganeh did not attend the Doha meeting, but, possibly signaling a compromise proposal may be acceptable, stated later in Tehran following a meeting with OPEC Secretary General Mohammad Sanusi Barkindo that “it is highly likely OPEC oil and energy ministers will reach an agreement.” Algeria’s Energy Minister Noureddine Boutarfa also said that the issue of Iran’s production would not undermine a deal. He said, “There is strong consensus among OPEC producers for a freeze.” He continued, “Iran is not a problem. Iran is a particular situation and needs particular treatment. They will not have the same rule for the reduction. We will study what is the best solution for Iran.”
Iraq argued in Algiers that it should be exempted from OPEC’s production agreement, saying that it is incurring a heavy financial burden in its military campaign against the Islamic State of Iraq and the Levant. Iraqi Oil Minister Jabar Ali al-Luaibi has also disputed OPEC’s use of “secondary sources” in its calculation of the 4.4 mb/d figure for Iraq’s September output, stating instead that Iraq produced 4.7 mb/d. The ministry even went as far as inviting energy reporters to visit Baghdad to discuss the discrepancies, followed by an unprecedented disclosure by the State Oil Marketing Organization of production levels on a detailed field-by-field basis. SOMO said its estimates of production in the Iraqi Kurdistan Region of around 550 kb/d were based on average production levels for 2013 and 2014, and appear inflated compared with current levels. The Kurdistan Regional Government later confirmed production for September was about 210 b/d less than what SOMO was reporting. There also appears to be some double counting of production from some fields in the north, which together appear to have inflated SOMO’s data, explaining why its numbers are higher than industry estimates reported by OPEC.
Iraq said on November 21 that it plans to submit three new proposals for an agreement at this week’s meeting of technical experts without going into further details. When Barkindo met Iraqi Prime Minister Haider al-Abadi in October, Abadi said that Iraq insists on being exempted from OPEC’s production agreement, but that Baghdad will not be an obstacle to the accord. Iraqi oil officials project output to increase by around 150 kb/d in 2017, which includes production of 70 kb/d from fields recaptured from ISIL.
OPEC Agreement in Reach But Probably Without Russia
With Iran and Iraq adopting slightly more conciliatory postures, an agreement to reduce production to 32.5 mb/d may be within reach when ministers meet in Vienna, OPEC officials said. A meeting of technical experts on November 21-22 ended without resolving issues related Iranian and Iraqi production targets, leaving the final negotiations over the two countries’ level of participation for the ministerial level. Reflecting the more optimistic outlook for an agreement, WTI has gained $4/bbl to $47.50/bbl in the last six days of trading. Nonetheless, market analysts will be closely following post-meeting statements by OPEC to assess the credibility of any agreement announced, especially from Saudi and Iranian officials. The accord will be judged on a number of factors: whether the group is able to accommodate Iraqi and Iranian demands; whether individual country quotas are pegged to an agreed baseline production level, or the weaker option that sets a fixed volume to be cut by each country without specifying an official target; and adoption of a formal mechanism for verifying credible production figures from member states. OPEC has found it very difficult in the past to resolve these perennial problems and it is not going to be any easier now to deal with these challenges.
Russia has engaged in high-level talks with OPEC officials during the past few months but has yet to pledge concrete steps to reduce production and, in fact, has raised production to a post-Soviet Union record of over 11mb/d. The Kremlin appears to be backpedaling from actual cuts to justify freezing output, albeit at record levels. Saudi Deputy Crown Prince Mohammed bin Salman and Russian Oil Minister Alexander Novak signed an agreement in early September on the sidelines of the G20 summit in China to cooperate in world oil markets, saying they could limit output in the future, but will not act independently.
In late October, the Russian minister visited Riyadh, meeting his Saudi counterpart, but few concrete details of the meetings have emerged. After the meeting, Novak was quoted in a Saudi ministry statement saying that the parties had discussed specific production limits for Russia and other non-OPEC states that may join OPEC’s production agreement, although no figure was mentioned, nor was there any confirmation from Moscow. Russia has a history of noncompliance with agreements it makes with OPEC and this time may be no exception.
OPEC is banking on a formal agreement to reduce production in Vienna, the first in eight years, to lift oil prices to a higher $50-60/bbl range in 2017. Prices at these levels are seen as a Goldilocks band, high enough to increase revenue for beleaguered oil producers but not too high to trigger a wave of new output from the U.S. shale patch. Finalizing a binding, transparent agreement is far from certain at this point, and even if OPEC were to hammer out an agreement, some market analysts see a more modest price recovery at a lower $50-55/bbl range next year given the still substantial record level of stocks weighing on markets.
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