It's possible that OPEC is crying wolf with hints of an output freeze next
month in Algiers; but it's also possible that they are ramping up production to
take the sting out of a freeze. This is a delicate balancing act that the
Saudis need to play very carefully.
The official chatter is that the OPEC meeting in Algeria from September 26
to 28 could conclude with an agreement to freeze production by the member
nations, with even Russia joining forces in a freeze that may prevent further
oil price erosion. But everyone's a bit gun-shy after the false hopes of the
last round in Doha—even if a freeze at levels that existed then wouldn't have
meant much either—and it's hard to blame them. The question is, how many
times can the Saudis cry wolf without forever losing the ability to leverage
this chatter to affect a rise in oil prices?
But lets rewind a bit to the nature of the recent chatter. The Saudi
Energy Minister has indicated that Saudi Arabia, OPEC's largest producer, is
willing to proceed with a production freeze.
"We are, in Saudi Arabia, watching the market closely, and if there
is a need to take any action to help the market rebalance, then we would, of
course in cooperation with OPEC and major non-OPEC exporters," said
Saudi Energy Minister Khalid Al-Falih, reports Reuters.
"We are going to have a ministerial meeting of the International
Energy Forum in Algeria next month, and there is an opportunity for OPEC and
major exporting non-OPEC ministers to meet and discuss the market situation,
including any possible action that may be required to stabilize the
market."
The hopes of reaching an agreement in Doha were scuttled by Saudi Arabia,
because it wanted its arch rival, Iran, to participate in the freeze.
Unfortunately for oil prices, Iran had made
it clear that it would not join any such discussion until they reached
pre-sanction levels of oil production.
What has changed from Doha to Algeria?
Iran
Iran's oil production is close to its pre-sanction
levels, meaning that its first cited prerequisite for any discussion has now
been met—a criteria that was not met at the time of the Doha meeting. In addition,
increasing oil production further by Iran is a big ask—it would need billions
of dollars worth of investments in both upstream and downstream facilities to
make this happen. With oil prices languishing below $50 a barrel, major oil
companies are reluctant to commit huge sums of money for new oil projects.
Iran's oilfields are mature, and more than half of its wells have an
annual decline rate of 9
percent to 11 percent, according to Michael Cohen, an analyst at Barclays
in New York. Therefore, at their existing production levels, they need an
additional 200,000 to 300,000 barrels a day annually to replace the shortfall
from their aging wells.
Iran needs more money and investment to continue pumping at the current
rate, making it more likely for Iran to agree to some kind of an arrangement
where they continue to pump oil at a rate close to their target of 4 million
barrels a day.
That said, the last thing that Iran wants is to be sidelined, so Tehran is
bound to make its presence felt at the meeting with strong statements. But at
the end of the day, it is unlikely that Iran will scuttle an agreement where
it has everything to gain and nothing to lose.
"There may be a little bit more to it this time. I'm still very
skeptical, but it's just with Iran being where they are production-wise,
they'll be more inclined to eventually go along with a deal," said Again
Capital's John Kilduff, reports CNBC.
Saudi Arabia
The oil-rich nation underestimated the resilience of the U.S. shale oil
drillers when they declared war on them in 2014. American oil has not only
kept flowing—the shale producers have managed to bring down production costs
considerably. This ability was not anticipated by Saudi Arabia.
Meanwhile, Saudi Arabia has burned more than $175 billion in reserves
since August 2014. The Saudis have introduced austerity measures and plans to
monetize their crown jewel Saudi Aramco to survive the oil downturn.
Nevertheless, things are not going well for this nation, which youth is
struggling to find jobs as shown in the chart below.
A large population of unemployed youths who cannot take care of their
families can sow seeds of frustration, and the Arab Spring will still be
fresh in the memory of the rulers.
Saudi Arabia is struggling to grow in this oil downturn. Barring the 2009
dip, the current growth rate of 1.5 percent is the worst in a decade,
according to data compiled by Bloomberg.
If oil prices remain low, the Saudi plan to sell shares in Saudi Aramco
might not fetch them the valuations they expect, and a nation that cannot
provide the most basic of amenities—food for its foreign workers—says a lot
about their financial condition.
Saudi Arabia has seen the recent slide in crude oil prices towards the
$40/barrel mark, which could have gone deeper without the chatter of a
production freeze. And since they have already cried wolf once in Doha, doing
so again in Algiers decrease the importance of any ‘chatter' leverage they
have in the future.
Rest of the nations already onboard
Barring Iran and Saudi Arabia, the rest of the nations were in agreement
about the need to freeze production during the Doha
meeting.
From OPEC to Russia, everyone is at record production levels
The oil-producing nations want to ensure that even if there are talks of a
production freeze, they should not feel the pinch. Hence, even before the
meeting, they will try to produce more, rather than less. The recent ramping
up may very well be an indication that a freeze—although at a level higher
than what would have likely come out of the Doha meeting—may be on the
horizon.
The oil markets are so sensitive that even a statement of agreement by
OPEC at the end of the meeting is enough to send oil prices flying above the
resistance level of $51 a barrel.
What about the shale oil producers?
Though U.S. production is declining and experiencing a flurry of
bankruptcies, the remaining companies are much better positioned to continue
pumping at lower levels to survive the downturn.
Though the risk remains that the shale oil drillers will come back in full
force when oil prices recover, the risk is worth taking. OPEC and Russia have
realized that any new world order will have to include the shale oil
companies. They are a large enough force not to be neglected or defeated.
With all of this in mind, an agreement between OPEC and Russia is more
feasible in Algiers than it was in Doha. It might not mean much though, with
output levels soaring ahead of the meeting. A freeze at current levels—or
levels reached by the time of the meeting—won't do much to change the
fundamentals, nor is there any indication that a freeze would have long legs.
