OPEC members may freeze production, but they are not going to cut. That was made clear on Tuesday at IHS CERAWeek conference by the Saudi oil minister, and the market sold off on the news.
In a highly anticipated speech, Saudi Arabia’s Oil Minister Ali Naimi laid out his views on the oil markets and the philosophy behind his country’s current policy in front of key figures in U.S. energy industry.
Naimi said that there is no use in taking coordinated action with other OPEC producers to cut output because other members would not go along. “That’s not going to happen,” Naimi said, referring to a production cut, adding, “There’s a lack of trust.”
Although Naimi did not call out any OPEC members by name, it was clear that he was referring to the likes of Venezuela, Iran and Iraq as producer countries that would not likely curtail output even if they said they would go along with any cartel action.
Naimi said that there is no use in taking coordinated action with other OPEC producers to cut output because other members would not go along, citing trust issues in cartel.
He was, however, upbeat about the much-talked about production freeze between Saudi Arabia, Qatar, Venezuela and non-OPEC producer Russia that was agreed this month in Doha, saying that by capping output, rising demand would eventually tighten fundamentals and bring down inventories. The freeze had given hope to market bulls who saw it as a step toward more aggressive action. But since Naimi has ruled out a cut, and if the Saudis continue to follow through with that policy, a price recovery may be longer down the road than many expect.
“Freeze is beginning of a process, that means if we can get all major producers to agree not to add additional barrels, then this high inventory we have now will probably decline in due time,” Naimi said. “It’s going to take time.”
In his speech, he discussed OPEC’s decision to not cut production at the group’s November 2014 meeting when prices were falling dramatically. Saudi Arabia met with non-OPEC producers to collaborate on stabilizing the market, but since none were willing to go along with the cartel, the Kingdom decided to let price and the marginal barrel rebalance fundamentals.
“The oil market is much bigger than just OPEC.”
Naimi told the audience: “Back in November 2014 at the OPEC meeting, there was a clamor by many for the group to cut its production to arrest the fall. But the oil market is much bigger than just OPEC. We tried hard to bring everyone together, OPEC and non-OPEC, to seek consensus. But there was no appetite for sharing the burden. So we left it to the market as the most efficient way to rebalance supply and demand. It was—it is—a simple case of letting the market work.”
This statement reflects Saudi Arabia’s current market policy, too. The Saudis have not said that they are against throttling back to shore up prices. It’s simply the case that the Kingdom does not want to shoulder the entire burden of production cuts. Without support from its rivals in OPEC and key non-OPEC producers, the Saudis would essentially be cutting to subsidize others in the industry.
“The role of OPEC remains to really try as best we can to balance supply and demand, to make sure there are no shortages of supply in oil markets,” said Naimi, whose country is the only producer in the cartel that has workable spare capacity that can be brought online in case of a supply disruption. “That is the primary role of OPEC. This business of defending price came much later, and the country that sacrificed for defending the price is Saudi. We are still willing to do that but we are going to do that differently—we are going to let everybody compete.”
Naimi, similar to others at the conference, highlighted that the oil industry is cyclical and was confident the market will eventually rebalance and prices would recover, but he did not give an exact timeframe when that will happen.
“During my seven decades in the industry, I’ve seen oil at under $2 a barrel and at $147, and much volatility in between,” said Naimi. “I’ve witnessed gluts and scarcity. I’ve seen multiple booms and busts.”
“While the parallels with experiences in past cycles can be instructive, every era is different. This is not the 1980s.”
He emphasized that today’s supply overhang and low price environment is different than previous down cycles, not least of all because of the growing complexity of the oil market. “While the parallels with experiences in past cycles can be instructive, every era is different. This is not the 1980s,” he said. “We are dealing with a challenging market that is much more sophisticated and complex. There are a lot of new players and financial instruments that simply didn’t exist 35 years ago.”
He was quite jovial in his comments, saying that in his many years in the industry he’s even “survived peak oil” and has a shirt somewhere to prove it. When asked on stage by IHS CERAWeek Chairman Daniel Yergin about when the market would rebound, he joked that if he knew that, he’d head to Las Vegas. OPEC Secretary-General Abdallah el-Badri, speaking at IHS CERAWeek on Monday, made a similar comment, saying that if he knew where prices were going, he’d quit OPEC immediately. Faced with a question about market speculation and its effects on the market, Naimi said they impact prices only in the short term, “but the short term is here to stay.”
In other words, no one, even top veterans of the market, can give a definitive outlook on oil prices, reflecting how much uncertainty now persists throughout every part of the industry.
Saudis and shale to coexist, but not always peacefully
Naimi made it clear that the Saudis are not at war against high-cost U.S. shale, but was quick to pivot to the fact that right now the carnage in the oil industry is a “simple, simple case of letting the market work” to weed out high-cost production.
“Let me say for the record, again, we have not declared war on shale or on production from any given country or company,” he said. “We are doing what every other industry representative in this room is doing. We are responding to challenging market conditions and seeking the best possible outcome in a highly competitive environment.”
“We have not declared war on shale or on production from any given country or company.”
Several times in his speech, the Saudi oil minister noted that the Kingdom is committed to meeting customer demand, rather than—contrary to many press and analyst reports—fighting for market share. The marginal cost will drive the market instead of OPEC managing fundamentals, Naimi stated.
Naimi added: “Efficient markets will determine where on the cost curve the marginal barrel resides. The producers of those high-cost barrels must find a way to lower their costs, borrow cash or liquidate. It sounds harsh, and unfortunately it is, but it is the most efficient way to rebalance markets. Cutting low-cost production to subsidize higher cost supplies only delays an inevitable reckoning.”
It’s understandable why the oil market sold off on Naimi’s comments, given that he appears determined to let “market forces” work instead of taking action to shore up prices in the short run. Market forces worked when prices were high—as they were over $100 per barrel for several years, “every barrel on earth was being produced.” That massive investment led to the oversupply currently in the market. The opposite is occurring now. The low price is choking investment. Prices will eventually rise, but as Naimi and El-Badri have stated, nobody knows when that will happen.