Wednesday, 17 February 2016

An unimpressive Saudi/Russia oil production deal

A secret meeting in Doha between senior energy officials from Russia, Saudi Arabia, Qatar and Venezuela agreed this morning to freeze oil output productions in an attempt to reduce the current supply glut.

However, the deal is contingent on all Organisation of the Petroleum Exporting Countries (OPEC) agreeing to the plan. Iran’s absence from the meeting points to severe disagreement on how best to cut production, making it unlikely the half-hearted proposal will reduce the growing oversupply of crude and raise market prices.

Saudi oil minister Ali Al-Naimi told media after the talks that freezing output at January levels will be “adequate” and Riyadh still wants to meet the demand of its customers.

A hurting oil market and disappointed OPEC member Venezuela were hoping for a more robust deal to stem production but the deal exacerbates a painful trend in crude markets.

The agreement freezes production at near record levels, based on production output measured in January. Last month saw some of the highest production levels among OPEC countries in decades.

Saudi Arabia produced 10.2 million barrels per day (mb/d) in January, a figure close to its 10.5 million barrels per day (mb/d) peak last summer. (The country typically produces more oil during the summer months to feed domestic cooling needs.) Before 2015, the OPEC heavyweight had not produced more than 10 mb/d in over thirty years.

The other party in the talks, Russia, is also at near record levels of production. In January, it pumped 11.2 mb/d, close to its peak of 11.3 mb/d earlier in 2015. Neither Russia nor Saudi Arabia can appreciably increase production beyond their current levels anyway.

Once again, Saudi Arabia’s obvious snub of Iran in the talks underscores the two country’s geopolitical competition played out in the oil markets. Given their competition, a broad agreement across OPEC was unlikely anyway, even if Iranian officials were invited to the talks.

Iran plans to increase production by 500,000 to 1 mb/d this year, and just as it shakes off years of sanctions, it is hardly in Tehran’s interest to cap production. Its first Europe-bound shipment of crude will also soon arrive. Europe was an important market for Iran before the stricter 2012 sanctions cut off trade and Iran is hoping to retrieve some of its old market share.

Should Iran and OPEC adhere to the deal – a situation not guaranteed – the production freeze may not be effective in easing the oversupply glut. Judging by the reaction in the markets – oil prices staged a brief rally but the gains were quickly obliterated as reality set in – oil traders are disappointed with the outcome.

Meanwhile, rumours persist that OPEC members could bring its planned June 2 meeting forward in what would constitute an emergency summit.  UAE’s energy minister Suhail Mohammed Faraj Al Mazroui told the Wall Street Journal OPEC is “ready to cooperate,” though only with “total cooperation from everyone”.

Whether the emergency meeting takes place or OPEC decides to wait until June, its officials will use the intervening time to reappraise their current production strategy. But judging how misaligned OPEC appears in this weak deal, it may not be until 2017 before the energy market corrects itself, says Energy Aspects' analyst Dominic Haywood.

In the meantime, Russia and Saudi Arabia show no signs of trimming production and are clearly prepared to weather extended low prices as part of a strategy to drive out higher-cost producers and secure greater market share.

The participants in the Doha talks plan to meet with the oil ministers of Iran and Iraq in Tehran on February 17.

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