Saudi-Russian coordination instrumental in OPEC agreement
It is necessary to diversify national economies, stop reliance on oil rent alone, provide for rise of several productive economic sectors.
2016/12/11 Issue: 85 Page: 19
The Arab Weekly
Beirut - Oil ministers of the Organisation of the Petroleum Exporting Countries (OPEC) surprised the markets by announcing an agreement that called for a 4.5% production cut that would decrease OPEC production 1.2 million barrels per day (bpd) to a target ceiling of 32.5 million bpd for the first six months of 2017.
The cuts may be renewed for another six months upon the agreement of the council of ministers in a meeting May 25th. Non-OPEC producers have also pledged to reduce output by 600,000 bpd, leading to a total production cut of 1.8 million bpd. Russia will lead the non-OPEC cuts with a 300,000-bpd reduction.
The cuts are projected to decrease the record-level crude oil storage globally. Oil producers had marathon talks during the past few weeks. Saudi Arabia and Russia, the world’s two biggest oil producers, played a pivotal role in ironing out the many differences among the producers.
The agreements’ modest achievements are expected to establish a floor price of $50-$55 per barrel, a range that would assure producing countries revenue increases of billions of dollars. A major driving force behind the agreement is the financial constraint experienced by those countries during the oil price crash of 2014-16. They want to avoid a third year of low oil prices. Many of them are worried about the political consequences of prolonged budget constraints.
The floor price of $50-$55 per barrel is in the range of most of the producing countries’ oil price estimate in their budget projections. The projected floor price remains below the price range that would trigger a resurgence of US shale oil production, which costs approximately $55-$75 a barrel to produce.
A $50-$55 per barrel Brent price would also stimulate investments in the upstream sector. There is much concern in the global oil industry that a shortfall of investments will result in an imbalanced supply and demand in global oil markets before the end of the decade, leading to a resurgence in oil prices.
Markets reacted positively to the agreement, rising quickly about 10% to $50 per barrel. Observers continue to question the credibility of the agreement and how faithfully the countries will adhere to their pledges. Many questions have been raised about Russia’s commitment to its pledge. Some large Russian firms had announced that they plan to increase production in 2017.
A Russian energy source briefed on the discussions said: “President [Vladimir] Putin wants the deal… Russian companies will have to cut production.” The Russian economy is heavily dependent on oil rent. The price crash of 2014-16 caused many constraints in the Russian economy.
Russia and Saudi Arabia, the world’s two largest oil producers, cooperated closely to forge the agreement, succeeding to enlist support modifying the positions of the main producers (Saudi Arabia, Iran, Iraq and Russia).
Russia’s main role was to negotiate with rival OPEC producers, mediating differences that OPEC members could not reach on their own because of their rivalries. Putin “played a crucial role in helping OPEC rivals Iran and Saudi Arabia set aside differences” to forge the agreement, Reuters reported.
Iran agreed to a modest increase in its allocation to 3.797 million bpd, compared to 3.75 million bpd and 3.78 million bpd during the past two consecutive months, instead of holding to its demands of a pre-sanction 4 million bpd production level and 12.7% of gross OPEC production. Saudi Arabia also agreed to take a cut of 486,000 bpd — the largest among OPEC states — and to be assigned a new allocation of 10.058 million bpd.
Iraq, the second largest OPEC producing country, accepted a cut of 210,000 bpd, the second largest reduction among OPEC states, to be allotted a production level of 4.351 million bpd. The Iraqi reduction was from the government production figures, as Baghdad had protested the use of secondary sources (energy news agency and consulting houses figures) used as a reference by OPEC.
The organisation, however, will continue using secondary sources as its main reference for production figures. OPEC established a committee of Kuwait, Algeria and Venezuela to review the monthly figures.
The encounter between OPEC and non-conventional oil is the first of many that are projected to flare up. Much will depend on the price level, whether it will move to record highs of more than $100 per barrel, as it did in the pre-2014 period, or even if it surpasses the $55- $75 per barrel cost range of non-conventional oil production. It will also depend on how low the cost of producing non-conventional oil can decline.
The 2014-16 price crash has driven home an important message to OPEC countries. They cannot any longer plan their budgets on record-level prices, investing billions of dollars in white elephant projects or endure massive corruption practices and huge unproductive employment in the public sector. Such practices carry heavy financial burdens that low oil prices cannot sustain.
The main lesson of the recent oil price crash should drive home a second one to the producing countries. It is necessary to diversify national economies, stop reliance on oil rent alone and provide for the rise of several productive economic sectors such as agriculture, high-tech industries and tourism.