The Fuse

OPEC: What’s There to Fight Over?

November 28, 2016

Guest Post by Matthew M. Reed | @matthewmreed

Matthew M. Reed is Vice President of Foreign Reports, Inc., a Washington, DC-based consulting firm focused on oil and politics in the Middle East.

Expectations are high that the November 30 OPEC meeting in Vienna will result in a supply pact requiring that some members cut production while others freeze theirs. Such a deal has proven elusive all year. It slipped away most dramatically in April, when a similar deal fell apart at the last minute. Since then, OPEC production has risen by 1.2 million b/d—meaning the Organization has added the equivalent of one more Algeria to the market (plus a little extra).

This time, however, oil ministers from key member states all say they’re “optimistic” like never before. Iraq is maxed out and more inclined to seek a higher price per barrel today, while Iran’s production ceiling is within reach if not already achieved. These twin developments make it easier for OPEC to reach a deal now, as opposed to the last time OPEC met in June, but it’s far from a foregone conclusion. It’s now up to ministers to resolve the thorniest issues and find a formula that’s both impactful and durable.

This time, however, oil ministers from key member states all say they’re “optimistic” like never before.

Positive signals abound but the November 30 meeting will not be a cakewalk. To get a serious deal, Iraq and Iran must be brought on board; combined cuts must add up to more than one million b/d; and ideally non-OPEC producers, most importantly Russia, will reach separate follow-up agreements with OPEC. Only then does OPEC have a chance of balancing markets sooner and raising the revenue so many members desperately need.

Iraq has resisted cuts all year, arguing that it must produce as much as possible to make up for years of sanctions and war and to pay for today’s fight against ISIS. But Baghdad changed its tone just days ahead of this week’s OPEC meeting. “Iraq is ready to cooperate with OPEC and cut production,” Iraqi Oil Minister Jabbar al-Luaibi was quoted last week. Prime Minister Haider al-Abadi was crystal clear too. “What we lose in lowering production we will gain in oil revenues,” he said. “Our priority is to raise the price of a barrel of crude.”

A “fake” cut can’t be ruled out since it would at the very least create the appearance of harmony among OPEC’s top members.

What’s less clear, and remains to be resolved in Vienna, is from which baseline Iraq will cut. This is because Iraqi officials claim all of Iraq, including Kurdish territory, is producing 4.776 million b/d, when secondary sources estimate that it’s producing 4.561 million b/d. The difference is material for an OPEC cut as it amounted to 215 thousand b/d in October and in recent months the gap has swelled to 300 thousand b/d. (As Platts has reported, Baghdad appears to be “double-counting” some oil that’s produced inside Kurdish-controlled territory.)

OPEC is reportedly aiming for a production cut target of 4.5 percent. 4.5 percent of Iraq’s claimed output is equal to the gap between the higher official number and the lower secondary sources estimate. So if Iraq’s official—and possibly inflated—production number is the baseline for a cut, then Iraqi production might only be frozen at around 4.5 million b/d. No barrels would come off the market.

A “fake” cut can’t be ruled out since it would at the very least create the appearance of harmony among OPEC’s top members. But behind closed doors the Iraqis will be pushed to accept secondary source estimates, since they have yet to convincingly refute them, and because it would require actual cuts. Using the secondary source estimates for October as a baseline, a 4.5 percent cut would shave 205 thousand b/d off Iraqi production. Add that amount to what Saudi Arabia and GCC producers can contribute—a plausible 800 thousand b/d—and the one million b/d threshold is feasible. Without Iraq, OPEC’s second-largest producer, it may be impossible.

At home, when speaking to a domestic audience, Iranian officials have claimed higher production levels than they’ve reported to OPEC. They’ve even claimed that volumes today are higher than at any time since the Shah ruled Iran.

Iran represents a real challenge because its messaging has been so confused in the weeks leading up to the Vienna meeting. At home, when speaking to a domestic audience, Iranian officials have claimed higher production levels than they’ve reported to OPEC. They’ve even claimed that volumes today are higher than at any time since the Shah ruled Iran. Statements like these should raise eyebrows when all year Iran has said it would not consider freezing or cutting output until production reached “pre-sanctions” levels, presumably those that prevailed in the mid-2000s. Simply put: Iran can’t claim victory and ignore OPEC. This disconnect isn’t necessarily disingenuous either. If you count crude oil and lighter condensates, the case can be made that Iranian production is at its highest level in decades.

Is that good enough for Iran? Or are they confident production still has room to grow? There are good reasons to doubt that Iran can lift production much more. If Iran is effectively maxed out, will they concede that in Vienna—and at the very least commit to a freeze? I don’t know. They won’t say. Iran’s fellow OPEC members can only hope.

In early February, just after prices had clawed back above $30/barrel and it was obvious OPEC was weighing intervention, I wrote the following: “OPEC needs three things to secure a meaningful production cut: unity among its top five members [Saudi Arabia, Iraq, Iran, Kuwait and the UAE], 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.”

Those conditions hold true if the goal is balancing the market and raising prices. But almost 10 months later, Iraq and Iran are still toss-ups and U.S. oil production has stalled around 8.8 million b/d. The EIA forecasts that American production will tumble by only another 100 thousand b/d in 2017. Going forward, OPEC can’t expect the U.S. to contribute much more in terms of involuntary cuts, after production fell by 600 thousand b/d from 2015 to 2016.

Any deal is better than no deal for OPEC. In fact, with expectations high, failure this time around could seriously undermine prices. But the best possible deal is one that somehow incorporates Russia. While U.S. production fell over the last year, Russian output surged, averaging 10.73 million b/d in 2015 and surging to 11.2 million b/d in late 2016—coincidentally making up for lost American crude.

There’s some debate inside Russia about whether these volumes are sustainable but OPEC can’t begin to engage Moscow until it gets its own house in order first.

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