|#1562||1814||April 29, 2016||By Pavneet Chadha|
Sixteen countries including major Organisation of Petroleum Exporting Countries (OPEC) and non OPEC members failed in Doha, in the third week of April 2016,to agree to a negotiated production ‘freeze’ that would have provided some relief to an already oversupplied oil market. The crude oil prices have fallen from $110 in mid 2014 to $42 currently. The coordinated effort reflected a growing concern among major producers and exporters about low oil prices. It was hoped that the parties might cooperate to at least temporarily stabilize the market. The economies of some of these petro states dependent on oil revenues to balance their budgets have been affected the most. Venezuela is on the brink of bankruptcy. Nigeria’s revenues have been hit hard. Russia is suffering from recession and also has been involved in conflicts in Ukraine and Syria.
The freeze was first mooted in February 2016 after a dialogue between Qatar, Russia, Saudi Arabia and Venezuela. In the build up to the meeting, it was widely expected that a draft agreement for an output freeze, which would have capped production at January 2016 levels through October, would be agreed upon. Renewed expectations in the market meant that oil prices rallied to recover from a 12 year low of $30 in January. But the talks collapsed due to the insistence by Saudi Arabia that every OPEC member must subscribe to the freeze, pointing at Iran, which for its part did not even send a delegation. Russian energy minister said that certain OPEC members changed their position on the day of the meeting. The meeting ended with the host Qatar conceding that more time was needed for further consultation. This means that focus would now shift to the OPEC meeting in Vienna in June 2016.
In its last two meetings, the cartel led by its most influential member Saudi Arabia, has refused to cut production opting instead to preserve market share. OPEC produces more than one third of world’s oil production. Riyadh’s strategy over the last two years has been to continue to pump crude at record levels and wait for the other higher cost producers to be driven out of the market. In a keynote speech in February 2016, Saudi Arabian oil minister Ali Al-Naimi reiterated their stance saying “Inefficient producers will have to get out.” The strategy is particularly aimed at the shale producers in United States of America (US) who typically require crude oil prices to be in the range of $55-$70 to be viable. With a production cost of less than $10 a barrel, the House of Saud has the deepest pockets in the cartel and is in a better position to take the pinch of lower oil revenues in the short run. It has dipped into its vast foreign exchange reserves (about $750 billion) to finance its populist subsidies.
The kingdom does not want to play the ‘swing producer’ role, wary of its experience in 1980’s when it cut production but others in OPEC did not follow suit. The result was a substantial loss in market share. Production cuts especially in a cartel are susceptible to the ‘free rider problem’. Countries may refuse to honour the agreed upon quotas and simply free ride at the expense of other members. In fact the cartel has not subscribed to even its production ceiling of 30 million barrels per day (bpd), producing over 32 million bpd as per recent data. All the countries have been pumping at record levels in a bid to not relinquish market share and to compete with the frackers of United States.
The Doha meeting failure however reaffirms that Saudi decisions on energy policy have a profound geopolitical component, primarily their strategic concern over Iran. The geopolitical rivalry between Saudi Arabia, the largest producer in the cartel and Iran mean that low prices are here to stay and may become the ‘new normal’. The collapse of talks suggests that Saudis are willing to endure economic pain but would not agree to a deal which benefits its regional rival Iran. International Monetary Fund (IMF) has warned that Saudis will run out of reserves in the next five years due to large fiscal deficit under current policies. The Saudi defence budget has increased over 20% due to the intervention in Yemen civil war. They have announced austerity measures and plans to diversify the economy. But the Saudis hate Iran even more than they hate low oil prices.
Saudi Arabia is worried about Iran’s growing regional influence especially after the nuclear deal. The two countries are backing proxies on different sides of conflicts in Syria, Iraq and Yemen. Iran, free from international sanctions after a deal to limits its nuclear program, plans to ramp production up to 4 million bpd (pre sanction level) and has said repeatedly that it will not be a party to any production cut. In the last six months, the Islamic republic has added additional 400,000 bpd to its output.
Even if a deal to freeze output was agreed upon, its effect on propping up the oil prices would have been marginal. According to recent estimates, Russia is currently producing a post-Soviet era high of 10.9 million bpd. Saudi Arabia’s production is around 10.2 million bpd. A freeze at those record production levels is unlikely to spur prices unless there is a substantial increase in demand. The reality is that the glut in the oil market still remains. According to International Energy Agency (IEA), world supply is estimated at 96.4 million bpd while world demand stands at 94.8 million bpd. Why would Saudi Arabia abandon the strategy just when it looks like it is paying off? In the US, the number of bankruptcies has increased and the rig count has reduced significantly in the Bakken area and Texas. US production has also reduced from 9.6 million bpd to less than 9 million bpd in a year. The Doha meeting was an opportunity to show the world that Saudis will entertain the idea of a ‘freeze’ and at the same time shift the blame on Iran.
The author is Research Assistant at CLAWS. Views expressed are personal.