June 25, 2018

Oil Producers Agree to Increase Supply, for Now

Russian Minister of Energy Alexander Novak, Saudi Minister of Energy, Industry and Mineral Resources Khalid Al-Falih, UAE Minister of Energy Suhail Mohamed Al Mazrouei, from left, attend a news conference after a meeting of OPEC and non-OPEC members at their headquarters in Vienna, Austria, June 23. (AP Photo/Ronald Zak)
Russian Minister of Energy Alexander Novak, Saudi Minister of Energy, Industry, and Mineral Resources Khalid al-Falih, and UAE Minister of Energy Suhail Mohamed Faraj Al Mazrouei, from left, attend a news conference after a meeting of OPEC and non-OPEC members at their headquarters in Vienna, Austria, June 23. (AP Photo/Ronald Zak)
by Robin Mills

Mana al-Otaiba, former oil minister of the United Arab Emirates, shared a poem with OPEC at its Vienna meeting last week. It concluded, “By controlling the tap of your crude oil, you sufficed us and satisfied our needs.” The deal reached on June 22 satisfies the needs of the key players – in and outside the organization – for now, and gives space until the next crunch time in November.

According to the communique, the update of the November 2016 accord between OPEC and non-OPEC members (OPEC+) agrees to “strive to adhere to the overall conformity level” of OPEC, excluding Libya and Nigeria, to have production hit target levels but not go beyond. Saudi Minister of Energy, Industry, and Mineral Resources Khalid al-Falih said this would be an overall boost of 1 million barrels per day (mb/d), though this was not spelled out in the official communique. Of this, a theoretical 750,000 barrels per day (kb/d) would come from OPEC producers, and it would gain a likely 600 kb/d over the next few months.

The June 23 meeting of the Joint Ministerial Monitoring Committee confirmed non-OPEC members’ agreement, and that 250 kb/d of the overall increase would be allocated to the non-OPEC members. In effect, this would primarily be an increase from Russia and a small amount from Oman and the others.

There is still a difference of opinion over the new deal. Saudi Arabia believes that those members able to increase production will do so, as long as overall production does not exceed the group’s cap. In contrast, as Iranian Oil Minister Bijan Namdar Zanganeh indicated in a subsequent interview, Iran thinks members will stick to their existing quotas but those that have slipped below production allotments (such as Venezuela) will do their best to recover – i.e. essentially the status quo. This diplomatic ambiguity was required to reach a deal. But it means that OPEC’s brief period of returning to per-country quotas (though without calling them “quotas”) is over.

OPEC was under pressure to do something, in the face of continuing strong demand and heavy overcompliance on its planned production cuts. Venezuela, in particular, was 540 kb/d below its allocation in May, with production slumping further in June in the face of moves by ConocoPhillips to enforce an arbitration award by seizing key Venezuelan export assets and oil on Caribbean islands. Maturing fields in Angola have left it 120 kb/d under target and Libya’s exports are threatened by renewed fighting around the Ras Lanuf export terminal.

The United States’ reimposition of sanctions on Iran has not yet had much impact on its exports, but was on everyone’s mind in Vienna: The wide range of estimates for lost production, from 200 kb/d to 1 mb/d, creates great market uncertainty. U.S. production has been booming even more than OPEC anticipated, but is running up against pipeline constraints, and its extra-light crude oil is not well-suited to replace medium and heavy grades from OPEC and Russia.

In response to these problems, Brent oil prices briefly rose above $80 per barrel in May, before slipping back, partly on expectations that OPEC would ease its production cuts. U.S. President Donald J. Trump tweeted that OPEC was manipulating prices unreasonably high. India expressed concerns about the impact on its economy. Iran complained that OPEC should not succumb to U.S. pressure; it also did not want to agree to a production increase that will lower prices and  of which it cannot take advantage of because it was already bumping up against its own production capacity, and from now on sanctions are likely to constrain its exports.

Saudi Arabia had already boosted output in May, by 80 kb/d, a bit more than its usual seasonal increase to meet summer air-conditioning demand at home. Russia’s May production was flat but still a little above its target. Leading state company Rosneft tested an increase in its output.

Faced with such signals, for Iran to concede a production increase is unpalatable, but better than a collapse of the deal and a free-for-all.

The benefits of the permitted increase accrue to three (or perhaps four) OPEC countries, plus Russia, whose output could grow by about 200-400 kb/d.

The UAE, currently producing 2.85 mb/d, has 3.2 mb/d capacity with a target to grow to 3.5 mb/d, though this will not be reached this year. Some observers have cast doubt on Saudi Arabia’s official 12.5 mb/d total capacity (of which Saudi Aramco accounts for 12 mb/d and the Neutral Zone, shared with Kuwait, for the remainder), as the kingdom’s all-time high production was 10.72 mb/d in November 2016. The 600 kb/d Neutral Zone has been shut down since May 2015 over an environmental and political dispute, leaving Kuwait with about 200 kb/d of unused capacity.

Iraq has been trying to restore production from the fields around Kirkuk, which Baghdad retook from Kurdistan Regional Government control in October 2017, but some 200 kb/d of production is still offline due to a lack of pipeline access. A planned oil swap with Iran has not yet gone into effect. But Iraq could increase production later in the year with continuing field developments.

The total available from the main players, then, is from 1.45-3.7 mb/d. Other countries are hampered by mature fields or political problems and have no usable spare capacity. But OPEC+ overall has the capacity to fill in for substantial further losses from Iran and Venezuela; the outages are not as severe as 2011-15 when sanctions on Iran, Libya’s revolution, a growing presence in Iraq of the Islamic State in Iraq and the Levant, and civil wars in three smaller producers coincided.

OPEC’s calculations indicate there would have been a global 1.47 mb/d deficit in the second half of 2018, though the International Energy Agency has a lower figure. Now the extra production will fill most of that gap.

Despite political alignment with Iran, Russia has consistently pushed for production increases, against Tehran’s interest. Zanganeh quoted Winston Churchill (in fact stated by Lord Palmerston), saying that a nation has no permanent friends or enemies but only permanent interests. In truth, Iran had little negotiating power, being unable to raise production in the absence of major foreign investment – itself a consequence of sanctions but also of domestic infighting and bureaucracy.

The solidified Russian-Saudi coalition has now led to discussions over giving permanence to the OPEC+ cooperation by creating a new body grouping all 24 adherents (or presumably, as many as want to join). Saudi Crown Prince Mohammed bin Salman had in March spoken of a “10 to 20 year agreement.”

It has been mooted that this group might move away from OPEC’s one-member, one-vote policy, and give more weight to the larger producing members. Such a body might supplant OPEC (though it faces big obstacles), conflict with OPEC, or exist uneasily alongside OPEC. It would have the task of managing a drastically different oil market from the one that birthed the producers’ organization in the 1960s – contending with the challenge of shale and of a possible long-term shift away from oil.

But for now, the diplomatically fudged compromise has evaded the hard decisions. Oil prices rose at first but have now fallen back on expectations of higher supply. At OPEC’s November meeting, when the course of Venezuelan and Iranian production is clearer, the next verse of this poem will be written.

Robin M. Mills is CEO of Qamar Energy and author of “The Myth of the Oil Crisis.”