There’s much buzz right now about a possible emergency OPEC meeting and a production cut deal that could buoy world prices. Judging by the gyrations of the market, and how closely price moves track headlines about OPEC activity, it seems the organization’s demise has been greatly exaggerated. Venezuelan Oil Minister Eulogio Del Pino’s recent world tour of major oil capitals and the associated price bumps is proof enough that OPEC can move markets just by talking about moving markets.
Today’s market glut didn’t kill OPEC. Instead, it forced the group into hibernation, where it had little choice but to wait for a moment when it could assert itself again—confident that together more OPEC members could balance the market for longer. That momentous turning point hasn’t arrived yet and it probably won’t crystallize in the form of an emergency OPEC meeting. But over the next few months the stage will be set for a very interesting meeting in June.
Obviously, price is the biggest factor driving OPEC to consider cuts. Four more months of low (or lower) prices could yet sober up OPEC holdouts. The OPEC crude basket sold for just $28 a barrel earlier this month. Some grades are selling for significantly less and competition in spot markets also pushes down prices for certain producers.
“OPEC Fails” is the kind of doomsday headline that sends oil prices into a death spiral. OPEC’s most important members have made it clear they won’t meet unless a deal is virtually guaranteed.
The biggest obstacle to an emergency meeting is the absence of a framework deal. At least one key member—Iran—isn’t ready to play ball. Meanwhile, non-OPEC production is only just beginning to slump. Del Pino’s efforts, however aggressive and earnest, have not delivered a gameplan, the details of which could be finalized at an emergency meeting. Unless OPEC can come together with a framework deal in hand, an emergency meeting is not an option. The risk of failure would be too great and the damage done to OPEC’s credibility could be huge. “OPEC Fails” is the kind of doomsday headline that sends oil prices into a death spiral. OPEC’s most important members have made it clear they won’t meet unless a deal is virtually guaranteed.
There’s chatter about a 5 percent cut in “global production,” which for OPEC would mean a shared cut of 1.5 million barrels per day (mbd). Whether that’s enough to balance the market is an open question. What’s not in doubt is that OPEC needs all its top producers to contribute for political and practical reasons. As of December 2015, OPEC’s top five producers* were: Saudi Arabia (10.144 mbd); Iraq (4.13 mbd, although that number may reflect some Kurdish oil sold independently); Iran (3.35 mbd); the UAE (2.99 mbd); and Kuwait (2.93 mbd).
The GCC producers are ready to cut with help, but Iraq and Iran have resisted because of special circumstances. Iraq is at war with ISIS, while Iran is clawing its way back into the market after three years of crippling sanctions. Together they represent roughly a quarter of OPEC production. Using December 2015 data as the baseline, a 5 percent cut would lower Iraqi output by about 200,000 b/d and Iranian production by some 170,000 b/d.
Iraq came around last month when Oil Minister Adel Abdul Mahdi voiced support for a cut. “We should all agree on a certain level of production cut: 5 percent of global production will be very good; even less than that should be acceptable,” he told Reuters on January 21. Abdul Mahdi expressed confidence that a 1.5 mbd reduction was good enough. That leaves Iran as the sole holdout among OPEC’s big five. Given the terrible state of Saudi-Iranian relations, it’s unrealistic to assume Riyadh would pave the way for its archrival to cash in after prices rise. At the very least, Iran would need to commit to limit its oil output at a certain threshold or perhaps cut some if it rises rapidly and soon. Neither solution is likely at the moment because Iran is only just beginning to test the waters for its unsanctioned oil exports.
Iran’s top oil officials insist that the country will not discuss cuts or curbs until after its market share recovers to pre-sanctioned levels, when Iran produced 3.7 mbd. To what extent this strategy will affect price depends on which official you ask. Some are convinced Iran can ramp up production and recover its market share without distorting prices. Others express caution, arguing that Iran should gradually re-enter the market in order to protect fragile prices.
In the coming months we’ll learn who won this internal debate and how much Iran can ramp up production and exports. Exports to Asia will depend on the term contracts that Iran negotiates with major buyers in the coming weeks. Deals with China were renewed January 1, but other customers renew around April 1 every year. Europe is another top priority for Iran, where it hopes to revive trade that dried up after harsh oil sanctions were imposed in 2012. Previously, the EU imported almost 600,000 b/d from Iran. Oil Minister Bijan Zanganeh says that contracts will soon be revived with European refiners who are ready to take some 300,000 b/d.
If you’re waiting to see what Iran is capable of then you will have to wait for Asian buyers to renew contracts this spring and the Europeans to restart imports in the coming weeks and months. Iran’s new volumes probably won’t stabilize until May at the earliest. Thus, the next bi-annual OPEC meeting in June would be perfectly timed for a sober discussion.
What about non-OPEC cuts? The Saudi mantra going back to late 2013 is that OPEC simply can’t fix a glut this big without help. They saw non-OPEC production, particularly U.S. shale oil, as a runaway train sped up by high oil prices, which made the fracking method so lucrative. To date, OPEC members have consulted most with Russia but there’s little trust between the two.
To date, OPEC members have consulted most with Russia but there’s little trust between the two.
If OPEC is looking for non-OPEC cuts, then it can look to the United States. After peaking at 9.7 mbd in April 2015, “U.S. crude oil production is projected to decrease from an average of 9.4 mbd in 2015 to 8.7 mbd in 2016 and to 8.5 mbd in 2017,” the EIA wrote last month. Thus, a 1.5 mbd OPEC cut could be bolstered by a 700,000 b/d decline this year in the U.S. and another 200,000 b/d next year, if the EIA estimates hold. 2.4 mbd could disappear relatively quickly—and that’s before the oil industry’s recent wave of massive, worldwide capital expenditure cuts results in declines elsewhere.
OPEC needs three things to secure a meaningful production cut: unity among its top five members, even if it requires a special arrangement for Iran; confidence in baseline production numbers from which members will cut, which are subject to dispute and possibly oversight; and sustained and significant declines in North American production. The stars may not align in June but they are starting to converge.
*According to data directly reported by members to OPEC.