Economic gains associated with the Gulf reconciliation will be narrow and limited, and any economic momentum should be channeled to tackle longer-term challenges in the region.
OPEC oil producers are reaping the rewards of their September 28 agreement in principle to reduce production levels, with oil prices rising to the highest levels in more than a year and now trading in a $50-52 per barrel (bbl) range. That’s a gain of around $5/bbl on average over the past three weeks or an extra $167 million a day, equal to a very significant $5 billion a month, based on the group’s September production of 33.4 million barrels per day (mb/d).
OPEC’s surprise shift in policy at the Algiers meeting, where the group reverted back to pursuing production cuts to strengthen oil markets, appears to have put a floor under prices in the short term, at least until the group’s next formal ministerial conference in Vienna on November 30, when it will have to deliver action rather than just words.
The rise in prices notwithstanding, some oil analysts remain skeptical of OPEC’s ability to finalize the September agreement. Indeed, post-Algiers, investment bank analysts lowered their price expectations for the rest of this year and next, holding them at just under $50/bbl in the fourth quarter and trading below $60/bbl through 2017, according to a Wall Street Journal survey. Bearish analysts argue the group will be unable to reach consensus on its plan to reduce output to a range of 32.5-33 mb/d given the multitude of contentious issues that need to be resolved internally, as well as securing participation by some key non-OPEC producing countries, especially Russia.
Three major issues loom large for the next meeting: agreeing on a production baseline from which to cut; negotiating individual country quotas; and determining a mechanism to exempt Iran, Libya, and Nigeria from the agreement. The three countries have been producing below their capacity because of international sanctions (Iran), or armed conflicts and destruction of oil-surface facilities (Libya and Nigeria). The countries all plan to raise output as soon as possible but there is much skepticism as to whether they can achieve their goals in the short term, particularly whether Nigeria and Libya can restore sufficient law and order.
However, other analysts are cautiously optimistic an agreement will be reached, arguing the severe drop in oil revenue since mid-2014 is forcing members to adopt a more pragmatic and flexible approach in negotiations, as witnessed in Algiers. They reason that the proposed agreement as it stands is not overly ambitious and appears largely designed to support oil prices over a short period of time while supply and demand rebalance, a process now forecast to gather steam in the second half of 2017. The framework agreement is for only a relatively modest cut in output of 600,000-900,000 b/d for six months, which will not require significant sacrifices. Indeed, Saudi Arabia, Kuwait, and the United Arab Emirates are expected to shoulder a major share of the production cuts.
Moreover, despite a history of failed agreements, the optimists maintain that OPEC managed to reach meaningful agreements in the past when oil prices posted similar steep declines. The last time OPEC agreed to a collective cut in production was 2008, when the global economic recession pressured oil prices sharply lower, from around $100/bbl at the start of the year to just below $40/bbl by the end of the year. At the time, oil demand growth was contracting and eventually declined by a steep 1.7 mb/d from 2008-09. OPEC engineered a cut in production at three meetings in 2008, with quotas lower by a total 4.2 mb/d, including a final 2.2 mb/d cut effective January 1, 2009. Actual volumes reduced were a smaller 2 mb/d in 2009 as some members like Venezuela ignored the new agreements but the cuts nonetheless managed to restore a semblance of stability and lift prices higher.
A Goldilocks Price Band
The financial imperative to increase oil revenue is also driving the political will to reach an agreement in November. OPEC producers have lost more than $1 trillion in oil revenue over the past three years, according to OPEC Secretary General Mohammad Sanusi Barkindo. OPEC’s decision to abandon its laissez-faire market share policy was recognition that the rebalancing of oversupplied markets was taking longer than expected and the suffering from lower oil prices had reached its limit.
Crucially, Saudi Arabia, among others, believed action was needed to avert another sharp fall in prices. Left unsaid by OPEC, it appears Saudi Arabia, among others, is effectively seeking a Goldilocks price band of $50-58/bbl, not so low that revenue contracts further but not so high that companies reinstate plans to develop higher cost production, like deep-water projects. While there is recognition that even in the in between range some shale oil production is likely to recover, only a portion of the fields can operate below $60/bbl. Indeed, there is a growing consensus among industry executives that oil prices may hold in the $50-60/bbl range for the next several years.
After two years of volatile lower prices and plummeting oil revenue, OPEC is hoping to put a floor under prices at slightly higher levels. OPEC members are facing staggering budget deficits, with even the richer Gulf countries issuing bond offerings at an unprecedented rate this year to raise cash to offset lower oil revenue. Standard & Poor’s estimates that the Gulf Cooperation Council countries may require up to $560 billion in funding from 2015-19 to cover fiscal deficits triggered by sharply lower oil prices.
Indeed, Saudi Arabia’s support for a more proactive OPEC policy comes amid efforts to shore up government finances with its first international bond offering this week. The multitranche offering is expected to raise $17.5 billion. A continued decline in oil prices would have likely undermined the prospects for the bond sale. The prospectus said the government expects a budget deficit of $87 billion in 2016. For Saudi Arabia, which produces almost one-third of OPEC’s total production, the latest $5/bbl rise in prices equates to an extra $52.5 million a day or $1.7 billion a month, based on its estimated September production of 10.5 mb/d.
Consultations Already Underway
OPEC and non-OPEC producers have already started holding discussions to try to reach common ground prior to the November meeting. OPEC President Mohammed Bin Salah Al-Sada and Barkindo held a series of informal meetings with some OPEC and non-OPEC oil ministers on the sidelines of the 23rd World Energy Congress in Istanbul on October 12. Saudi Arabia’s Minister of Energy, Industry, and Mineral Resources Khalid al-Falih had to depart the gathering before the planned sideline meetings, but he held a series of bilateral talks with both OPEC and non-OPEC officials, including with his Russian counterpart. Afterward Falih said: “I can say that many countries from outside OPEC are willing to join … we are not talking about support, we are talking about contribution.”
Taking the market by surprise yet again, this time Russia’s President Vladimir Putin used the Istanbul meeting as a platform to confirm his country will join OPEC in limiting output. “In the current situation, we think that a freeze or even a cut in oil production is probably the only proper decision to preserve stability in the global energy market,” Putin told the Congress. Despite the very public proclamation, analysts have largely dismissed the statements as lacking credibility given Russia’s failure to meet its commitments to OPEC in the past. A meeting of technical experts to hammer out details of the agreement is scheduled for October 28-29 in Vienna.
The steady stream of bullish statements by OPEC officials about an agreement has disproved the old adage that talk is cheap, given the rise in oil prices. Equally, having raised market expectations that an agreement to reduce production is imminent, failure to do so at the end of November could have a catastrophic impact on oil prices. Near term, analysts will be closely following the latest data on supply, demand, and stocks to assess whether the proposed cuts will be enough to significantly hasten the rebalancing of an oversupplied market, with a special focus on the November oil market reports from the international forecasting agencies.
The October oil market reports from the International Energy Agency and the OPEC Secretariat were largely unchanged from the previous month and had little impact on the outlook. OPEC production was assessed as marginally higher in September but the small increase nonetheless pushed the group’s output to a record level. Both the IEA and OPEC expect global demand growth to remain robust for the remainder of this year and next, with annual growth of around 1.2mn b/d for 2016 and 2017, in line with the five-year average. The IEA expects fourth quarter demand to increase by 1.4 mb/d over 2015 levels, when unusually mild winter weather in much of the northern hemisphere tempered demand. OPEC has drawn a relatively positive picture of oil demand, noting growth in Asia is also stronger, especially in India where gasoil and diesel fuels, used in the power, agricultural, and transport sectors, posted significant growth on the back of the general improvement in economic performance.
Notably, the IEA report showed global stocks posted only a modest increase for the third quarter, with “tentative signs that bulging inventories are starting to decline” in September. Overall, the IEA’s latest supply and demand outlook is largely unchanged from the previous month, with a rebalancing of markets not expected to take hold until the fourth quarter of 2017. However, the report said if OPEC reaches an agreement to reduce supplies, “the market’s rebalancing could come faster.”
Walid Khadduri is a non-resident fellow at the Arab Gulf States Institute in Washington.
Diane Munro is a former senior oil market analyst at the International Energy Agency and a contributing writer at the Arab Gulf States Institute in Washington.
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