OPEC agreement: is it sufficient?

Between 26th and 28th September the XV International Energy Forum in Algeria took place. On the sidelines of this event, the 14 OPEC members, along with Russia, held an informal meeting to discuss the possibilities of reducing the current oversupply on the market (more than 1 million barrels). This is the umpteenth attempt to encourage current prices since the start of a struggle for market share in mid-2014, as a result of the incursion of American shale oil.

Expectations were directed toward a new strategic plan for the next formal OPEC meeting to be held on 30 November in Vienna. The main differences with the previous formal meeting in Doha, held on April 18, have been, on the one hand, more fluid conversations between the protagonists countries and, secondly, the presence of Iran, absent at the last gathering.

Market situation prior to talks

OPEC members, who represent 40% of world oil production, came to the event with record production levels, exceeding 33 mbd in August. That is, around maximum levels never achieved.

Meanwhile, Russian production, which is not a member of OPEC but already accounts for 15.3% of world production, is approaching its historical record (11.4 mbd set in 1987). Thus, its current level stood at 11 mbd on average in September.

Current situation of the main oil producers

On the other hand, it has recently been known restoring production by Libya and Nigeria (both interrupted by internal conflicts). Libya has reached 450,000 bpd, and its goal is to reach 1.6 mbd, production had before the dictator Gaddafi ouster. Nigeria, reached a production of around 1.75 million bpd, and is expected to reach 1.8 mbd in October and 2 mbd in December. Thus, in this month, Russia, Nigeria and Libya, have added more than 800,000 bpd to the market compared to August.

Market oversupply was larger compared to that recorded in previous meeting. Recently, the IEA has updated its forecast for oil demand and supply, delaying the arrival of market equilibrium until the end of 2017. Stockpiles will continue its upward path and will cause the fourth consecutive year of oversupply with slower growth expected demand, especially from China and India.

Likewise, in the week before the event, the number of US oil rigs highs levels since February, which means the thirteenth consecutive week of growth and an increase of 32% since the end of May.

Under this scenario, what did Saudi Arabia offer? In the previous days, Saudi Arabia and Iran (first and third OPEC producer respectively) had held talks in Vienna. In this two-day meeting, Saudi Arabia proposed pumping less oil, namely return to quotas in January (which would cut around 500,000 barrels per day), with the condition that Iran freeze production at current levels (3, 6 mBD). This option was flatly rejected by Iran. It should be noted that it is the first time that Saudi Arabia intends to reduce its production. However, Iran joining any agreement is essential for the Arab Kingdom.

With all these facts, the chances of reaching an agreement were virtually nil.

Within the event week, statements from Saudi Arabia and Iran, saying the meeting would be consultative only, were confirming the predictable: there would be no agreement at this meeting.

Outcome of the meeting

With all these facts, the chances of reaching an agreement seemed very low. However, late Wednesday’s meeting, was concluded with an agreement of a modest production cut, the first one since 2008.

Reducing production has consisted of reduce output from 33.24 mbd currently estimated to lie in the range of 32.5 to 33 mbd OPEC. To reach this cut would mean a maximum of 750,000 barrels a day less in the market compared to the levels recorded in August, just over half the expected growth in demand this year by the IEA (1.3 mbd).

The effect on short-term was clear. Thus, the price of Brent increased more than 6%, reaching $ 49 / barrel after slight downward correction. Thus, crude posted their biggest gains since April.

However, it should be noted that we don’t know yet how this decline in production will be set, nor how market shares will be distributed. 32.5 mbd or 33 mbd to which it comes, will have to be distributed among OPEC members. These details should be discussed at the next formal OPEC meeting in Vienna on November 30.

In addition, OPEC will aim to convince producers outside the Organization, including Russia, to limit their production. While OPEC has reached an agreement in principle to cut production, Russia registered historical records of oil production. As mentioned earlier, production in September is 11.1 mbd, representing an additional 400,000 barrels compared to August.

Regarding the agreement, we must consider three important factors: 1) The details of how production will be cut will have to ratify in Vienna on November 30; 2) we have to wait what the US will do. It is expected that at higher prices, there will be an increase in the activity of producers of shale oil; and 3) Russia, which is not part of the agreement, will have to decide what to do. Meanwhile, if Libya and Nigeria stabilize production, we will have more supply in the market.

Enrique Battistini | Energy Consultant