The Fuse

Does OPEC, Russia Production Freeze Signal Potential for Future Collusion?

by Matt Piotrowski | February 16, 2016

Several OPEC countries, along with Russia, decided on Tuesday at a meeting in Doha to “freeze” production at current levels to stabilize the market. The decision, though newsworthy, is not likely to have any tangible impact on the market in the short run. Capping production levels simply preserves the status quo. Oil prices fell on the news.

“This is more a symbolic first step than a meaningful market correction. Key players still need to be brought on board, namely Iraq and Iran.”

Although Saudi Arabia, Qatar, and Venezuela agreed with Russia to keep output levels where they are now, the global oil market is still oversupplied, to the tune of about 1.35 million barrels per day, according to Energy Information Administration (EIA) data for the first quarter. More importantly, Iran and Iraq are reportedly not yet part of the deal, key OPEC member states since both are set to boost output. Iran is increasing its export volumes now that international sanctions have been lifted and Iraq continues to grow its supply at a fast pace. “Iran’s nuclear agreement was premised on the economic benefit from a recovery in oil exports, and so to agree to cap exports now as part of a wider OPEC deal would basically mean Iran had accepted restraints on its nuclear program in exchange for nothing,” said Tim Evans of Citi Futures in a note.

Oil prices gyrating over the past several weeks as a result of headlines about possible OPEC action in coordination with some non-OPEC actors reflects the instability that the cartel engenders. The market spiked over the past several trading days, with Brent reaching the $35 level on news of the Doha meeting, but prices backed off sharply to below $33.

The production freeze is the “beginning of a process” that could require “other steps to stabilize and improve the market,” Saudi Oil Minister Ali Al-Naimi said in Doha Tuesday after talks with Russian Energy Minister Alexander Novak. Saudi Arabia pumped 10.2 mbd in January, and the entire cartel produced 32.63 mbd, up almost 0.5 mbd from 2015 levels, according to the International Energy Agency (IEA). Despite the announced freeze from the Saudis and others, the group’s output could hit 33 mbd this year with growth from Iraq and Iran, according to a number of analysts.

“The freeze is better than nothing but it won’t do the trick,” Matt Reed, vice president of Foreign Reports in Washington, DC, told The Fuse. “This is more a symbolic first step than a meaningful market correction. Key players still need to be brought on board, namely Iraq and Iran, and more serious measures have to be considered, such as shared production cuts. If this is what OPEC members and non-OPEC producers need to build confidence, then it’s very welcome, but a serious, durable solution to today’s glut depends on OPEC unity and eventually action. Iran says it has already ramped up output and exports by 400,000 barrels a day. Iran has to decide whether that’s good enough for now given how low prices are. I think everyone recognizes that Iran’s circumstances are unique, but they can’t just be given a free pass. They have to contribute in some way.”

There’s the possibility, however, that Iraq and Iran may soften their stances. An Iraqi oil ministry source told Reuters today that Baghdad would commit to capping its output at January levels if OPEC and non-OPEC countries agree to a deal. “Iraq is with any decision that contributes to propping up oil prices,” said the source. Iran, meanwhile, is the bigger wild card since it has been adamant about increasing exports after years of sanctions.

Saudi Arabia has stopped short of curbing output in part because it is worried that higher prices from a cut would make room for more U.S. shale supply. Moreover, the Kingdom believes that if it throttles back, Iran and Iraq would simply grab some of its market share in Asia and Europe.

OPEC’s conundrum 

The production freeze shows the conundrum that OPEC and Russia, which is pumping close to 11 million barrels per day, currently face. Exporters don’t want to cut and cede market share to rivals, but all producers are hurting and need a higher price. There are growing worries that prices will remain at low levels for an extended period of time because of the massively high inventory levels, and many forecasts show supply exceeding demand throughout the year.

Although Saudi Oil Minister Naimi said the production freeze is the start of a longer process, it remains to be seen whether a production cut will eventually materialize. A cutback would likely put a floor under prices, but it would also give a lifeline to the beleaguered U.S. shale industry, which has taken a big hit from OPEC’s Saudi-led strategy to pump at high levels instead of throttling back to stabilize prices.

If OPEC and Russia are able to successfully collaborate on freezing, and possibly cutting, production, this action could have sweeping impacts in the future, when both are in a position of greater strength.

If OPEC and Russia are able to successfully collaborate on freezing, and possibly cutting, production, this action could have sweeping impacts in the future, when both are in a position of greater strength. As a result of today’s current underinvestment, fundamentals will eventually shift and OPEC members, along with Russia, will gain a larger grip on the market. OPEC countries hold some 80 percent of the world’s proven crude oil reserves and make up more than a third of the world’s current supply. OPEC’s market share has always been cyclical and is a major determinant for its pricing power. OPEC and Russia will be important players in the global market for years and decades to come. While they have been significantly undermined by U.S. shale growth, OPEC members and Russia appear determined to reassert their market power and will be better positioned when fundamentals eventually tighten.