OPEC Agrees to Agree to Cut

Transcription

1 OCTOBER 3, 2016 What Does The OPEC Decision Mean? OPEC Agrees to Agree to Cut The market has just about ended its love affair with an OPEC decision to cap production that lacks any details. Even before the week was out, analysts were pointing out the deal s obvious lack of substance. That just means most don t understand the dynamics of the next stage in global market readjustments. The prices for crude oil had spiked over the last three days of trading following an announcement that OPEC would cap production. Between oil s 2:30 PM Eastern U.S. close of trade on Tuesday and close on Friday, WTI (West Texas Intermediate) rose 8%. Meanwhile, Brent increased 6.8%. WTI is the benchmark crude rate traded in New York; Brent is the equivalent (and more globally used) benchmark set in London. The rally should now be just about over, as prices flatten out at a higher level, and markets must now await specifics on the deal. Yet these may not come much before the next regularly scheduled OPEC meeting set for the cartel s Secretariat in Vienna on November 30 meaning pundits are left with almost two months of vacant air to fill. I addressed the front end dimensions of the situation last week during my comments for CNBC from Algiers. There, OPEC members met in sidebar sessions taking place at the biannual International Energy Forum ministerial meetings. As sources have confirmed since then, however, OPEC has some serious work to do before the end of November to pull off something more than simply a cosmetic move. There is a pronounced lack of consensus within the cartel on how to achieve the cap or even what that cap is. Last Wednesday, the initial read was for a monthly OPEC production level of some 32.5 to 33 million barrels a day. That would put the effective aggregate amount at about the same level as the figure realized in January of this year. That level had been the target for an earlier cap proposed before the unsuccessful April producers meeting in Doha. With no agreement then, each subsequent monthly figure has simply increased the overall level of production. That played right into a classic shooting oneself in the foot syndrome. Global demand has been slowly moving up. But increasing supply in a desperate competition over market share has just

2 WHAT DOES THE OPEC DECISION MEAN? 2 further exacerbated the problems on the revenue side. The result has worsened acute central budgetary crises throughout OPEC and primary non OPEC producers such as Russia. In addition, the rising production levels are not sustainable in what remains a low pricing environment. Excessive pumping has already led to creaming at several fields. This refers to extracting the immediately available easy oil at the expense of reservoir integrity and pressure. The all in up front approach is costing production further down the curve. Compliance Problems A broader problem is already surfacing within the cartel. With the introduction of a production cap, OPEC will once again need to enforce monthly quotas for members. These had been suspended as countries opened up the taps to flood additional supply into the market. OPEC first determines global demand, then subtracts non OPEC supply to arrive at what is referred to as the Call on OPEC. That total is then divided into a monthly quota for each member state. Those quotas, in turn, use national production levels. Yet before the final figure has even been decided upon, there is disagreement surfacing over how it is to be determined. Remember, in this zero sum strategy put forth by all producers, each enhances market share only at the expense of some other player(s). There is no advantage to keeping volume in the ground unless all others do so as well. And this is further complicated by the increasingly desperate approach introduced over the past twenty months. All OPEC members have decidedly less financial leverage now than they did in early Phasing out a grab scenario takes time and without a road map is going to be difficult. This is where the speed bumps occasioned by national production figures come in. With the reintroduction of monthly quotas, some OPEC members will insist on initial production levels higher than the Secretariat in Vienna is prepared to accept. Each will still want as much a share in what is going to be (on paper at least) a shrinking pie.

3 WHAT DOES THE OPEC DECISION MEAN? 3 Iran & Iraq Moving in the Wrong Direction Pivotal in this calculation are Iran and Iraq. While both are members of OPEC neither has had a genuine monthly production quota for years. Iran has already declared it will not join any cap regimen until it has reached extraction levels prior to the imposition of Western sanctions. That is about 4.2 million barrels a day, or about 600,000 barrels higher than current levels. Iraq, on the other hand, has declared initial targets that are rather ambitious increases compared to earlier production. To date, Iraq has given little indication it can reach these increases any time soon. Yet it is a rising disagreement over current totals that poses an immediate problem to a cap. OPEC had used an August figure (the latest monthly total available) of 4.35 million barrels a day for the Iraqi base, while Baghdad says that figure is 4.62 million. Moreover, contacts in the Ministry of Natural Resources in the quasi autonomous Kurdistan Regional Government in northern Iraq have advised me the KRG is unlikely to abide by any decisions to cap production made by the central government. Forgetting for a moment volume problems from any other OPEC member, Iran and Iraq alone point to an additional 1.0 million barrels a day that are subject to quota limits, and thereby comprise additional production to be cut (not capped). Any of these additional barrels allowed into the figuring must come from other member states allotments and, thereby, comprise their additional lost revenues. Я пью ваш молочный коктейль! ( I Drink Your Milkshake! ) There is also the position of Russia. It has the largest observing delegation at the OPEC meetings and has developed a close working relationship with Saud Arabia. But several ministerial contacts at Minenergo are already telegraphing concerns over an OPEC initiative that provides no details. After what they considered a slap in the face at Doha, Russia will not be coming on board any cap without some better guarantees. Moscow had agreed in principle to a cap earlier this year using January figures, only to have Riyadh pull the rug out at the eleventh hour when the Saudis announced they could not agree to any move without the concurrence of Teheran. With the Iranians not even present for the Doha meetings, it was

4 WHAT DOES THE OPEC DECISION MEAN? 4 tantamount to scrubbing the entire deal. Several Minenergo contacts have already declared that there will be no move to another agreement without substantial OPEC guarantees that firm quotas will be introduced and adhered to. From the broader production perspective, American producers are not involved in these discussions. Given that there is no U.S. national oil company or centrally determined government oil policy, the advent of shale and tight oil largess in North America has directly impacted the global supply demand balance. Yet aside from the blunt pressure applied by OPEC on the pricing front, the cartel has no other direct way of influencing American production or involving it in any cap approach. What this OPEC decision actually means, therefore, cannot be determined until specifics are decided. This oil emperor really needs to find some clothes.

5 WHAT DOES THE OPEC DECISION MEAN? 5 About the Author Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment. He serves as an advisor to the highest levels of 27 countries, including the U.S., Russian, Kazakh, Chinese, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He s served as a consultant to private companies, financial institutions and law firms in 29 countries, and has appeared more than 2,300 times as a featured radio and television commentator. He appears regularly on ABC, BBC, Bloomberg TV, CBS, CNBC, CNN, NBC, Russian RTV, and the Fox Business Network. A prolific writer and lecturer, his six books, more than 2,700 professional and market publications, and over 650 private/public sector presentations and workshops have appeared in 47 countries.