OPEC: Towards a November Output Deal

Published on September 23, 2016
SGH Insight
We would watch for confirmation of technical working groups that will be formed — which will be focused on establishing new quotas — and for an affirmation from Iran that it will soon be approaching its 4 million bpd pre-sanctions production target. Those two signals would underscore what we understand to be substantial momentum in Saudi and Russian-led talks to shift OPEC away from an output freeze to a new overall ceiling and quotas agreement that could come into place as soon as the OPEC Summit in Vienna on November 30. It would include Iranian participation at its pre-sanction level, Russian “observation” of an implied quota and, crucially, a Saudi/GCC output cut.
Market Validation
(Bloomberg 9/18/16) OPEC agreed to the outline of a deal that
will cut production for the first time in eight years,
Oil jumped more than 5 percent in New York after ministers
said the group agreed to limit production to a range of 32.5 to
33 million barrels a day.

The agreement was possible because Iran will be exempt from
capping production, a major concession by Saudi Arabia, the
group’s dominant producer. Still, many of the details remain to
be worked out and the group won’t decide on targets for each
country until its next meeting at the end of November.

Key Takeaways:

An OPEC output freeze in Algiers next week is highly unlikely, but there is considerable momentum in talks led by Saudi Arabia and Russia to shift the policy debate to an overall ceiling and quotas agreement as soon as the November OPEC Summit in Vienna.

Riyadh is aiming for a crude oil price range between $50 to $60 a barrel through at least the end of next year, with a hard floor of $40 and a willingness to increase output to stem any sustained rise above the upper target.

September 23, 2016

Oil prices are again bouncing from headline to headline of the various OPEC officials talking up the prospects for an oil output “freeze” agreement at their meeting in Algiers next Wednesday. For good measure, the Saudis have gone public with their “offer” of a 1 million bpd output cut if the Iranians would freeze their output at current levels, which was rejected by Tehran as not genuine, which it wasn’t.

*** We think it highly unlikely any substantial agreement on an oil output freeze will be reached at the OPEC’s informal meeting on Wednesday, as we understand the negotiations for a freeze have all but run their course. Instead we would watch for confirmation of technical working groups that will be formed — which will be focused on establishing new quotas — and for an affirmation from Iran that it will soon be approaching its 4 million bpd pre-sanctions production target. ***

*** Those two signals would underscore what we understand to be substantial momentum in Saudi and Russian-led talks to shift OPEC away from an output freeze to a new overall ceiling and quotas agreement that could come into place as soon as the OPEC Summit in Vienna on November 30. It would include Iranian participation at its pre-sanction level, Russian “observation” of an implied quota and, crucially, a Saudi/GCC output cut. ***

*** Instrumental to a potential OPEC output deal is Saudi Arabia’s slow return to its traditional swing producer role. It is being driven by the need for stable oil prices as a backdrop to the planned Saudi Aramco IPO and, with the threat of US 9/11 lawsuits and election uncertainties, by Ryadh’s accelerating geo-strategic pivot to Russia on oil and Mideast policies, and to China and Asia for oil market share, munitions, and long term investors in its ambitious economic plans. ***

From Algiers to Vienna

There has been an endless run of headlines driven by various OPEC officials doing their very best to talk up oil prices in the run up to their coming talks this Wednesday in Algiers. No harm, no foul, but we would take their assertions with a grain of salt.

The meeting in Algiers, tacked onto the end of the Energy Forum Conference that opens on Monday, is an informal one with no pre-set decision making authority. And we seriously doubt such substantial progress would be made among the OPEC members to lead to a rapid “extraordinary” OPEC meeting. The Russians, for their part, have already said they are leaving Algiers on the 28th, and will not in any case participate in any agreement unless the OPEC member countries reach a prior agreement to limit their output, which is not going to happen.

In any case, our sense is that the scramble among some of the OPEC members like Venezuela to make further inroads towards a binding deal to “freeze” output at current levels has already run its course. Libya, Iraq, and Nigeria for one are demanding exemptions, and most of all, Iran will flat out refuse to participate until their output is back to its pre-sanctions levels above 4 million bpd that is a stated objective as a “sovereign right.”

Likewise, the Saudi offer of a one million bpd output cut should also be taken with a grain of salt. The Saudi offer, made at the end of informal talks in Vienna between Saudi Arabia and Iran, with Qatar acting as the intermediary, was not genuine in coming with the pre-condition the Iranians would have to freeze their output at its current levels of around 3.6 million bpd. The Saudis knew it would be rejected, which it was.

But both the Saudi offer, and any movement in Algiers to at least sign off on the formation of a technical working group should be taken as positive signs on the movement well underway behind the scenes towards a new ceiling/quotas based framework for an agreement that could come as soon as the annual OPEC Summit in Vienna on November 30.

The Iranians are said to lack the technical capability to sustain output much above that 4 million bpd mark, so there is some grounds for thinking that by November Tehran will be far more willing to come to the table on a quota-based output deal — especially if the Saudis finally agree to cut their own current record levels of crude output.

And it is our sense the Saudis may indeed be willing to commit to an output cut of up to around 1 million bpd, which would invariably entail some cuts in output from its Gulf Cooperation Council oil exporting allies like Kuwait and the United Arab Emirates.  One potential stumbling block that would have to be overcome, however, is addressing a Saudi demand the Iranians cannot expand current production to include a further increase in oil exports, which the Saudis argue has already reached its pre-sanction export level of around 2 million bpd.

The Kingdom’s  summer surge output is already winding down, there are maintenance shut-ins looming, and Riyadh has become far more comfortable with its secured market share in Asia, all of which we understand will be making the Kingdom more willing to deal if that is what it takes to secure a stable oil price outlook.

Saudi Arabia, in fact, has wanted to move the thrust of the OPEC/Russia negotiations to stabilize oil prices away from a freeze — any freeze with the Iranians at the higher ouput levels would look like a political setback — back to the traditional OPEC quotas that take into account a far broader array of factors like population, economic size, capacity, and importantly, spare capacity.

And while OPEC has forever wrangled over and then broken its output agreements, this time round may be that much easier since nearly all its members save Saudi Arabia are pretty much at their maximum output capacity — including Russia.

A Growing Saudi-Russia Axis

Importantly, this movement towards an output deal later this year will include the Russians, who have emerged as a key player, working with both the Saudis and the Iranians, and as the broker in the crucial talks between the Kingdom and Iran.

A Russian linchpin role was certainly in eivdence in Saudi Arabia’s attempt earlier this year to engineer an oil output freeze. After coaxing the Russians into process, the talks of course collapsed in Doha after the Iranians balked at the Saudi efforts to pull them into a premature deal on a freeze while still ramping up to pre-sanction targeted levels (see, among others, SGH 5/1/7/16, “Oil: Doha Collapse” and SGH 5/1/16, “Oil: The MbS Bombshell”).

In the months since, repair work has been underway to ease the strain in Saudi-Russian relations, leading to the energy agreement between the two oil superpowers reached on the sidelines of the G20 meeting in early September.

That was more far reaching than the markets initially believed, in that it was built around a Saudi commitment to follow through on promised investments by its Public Investment Fund in the Russian energy sector, Russian assistance in developing Saudi nuclear power plants, and apparently a degree of cooperation on market share in Asia.

And during the meeting between Russian President Vladimir Putin and Saudi Deputy Crown Prince Mohammed bin Salman – nearly within the same breath in praising the Deputy Crown Prince to an unusual degree — Putin also apparently took the initiative to prod the Saudis into the Vienna talks with the Iranians on the potential terms to an oil output deal, be it a freeze or the more likely new quotas.

Behind this growing working relationship between Riyadh and Moscow is a Saudi recognition of Russia’s position as not only a key oil power, whose participation can make or break an effort to balance supply and demand in the crude oil markets, but its newfound strategic role supplanting the US as the key power broker in the Middle East.

What’s more, Russia has adroitly positioned itself as the  “honest broker” between the Kingdom and Iran, much in the same way the US played that role between Egypt and Israel in the 1970s, when the Arab-Israeli conflict drove the wider Mideast political dynamics. Now it is the heated Sunni-Shia, Saudi-Iranian divide defining the Mideast, all of which is centered around the civil war in Syria, where the Russians are the key power with whom the al-Sauds have no choice but to work

Back to list