OPEC: Vienna Deal Looks Likely

Published on November 2, 2016
SGH Insight
In the last 24 hours or so, a compromise on Iraq’s participation looks imminent, which in turn should clear the way for a credible agreement at OPEC’s November 30 Summit in Vienna on the first cuts in OPEC output since 2008. The key breakthrough is what looks likely to be a Saudi concession to accept an Iraqi quota at their higher 4.7 million bpd output figure they recently asserted as their current output rather than the 4.1 million bpd figure used to formulate the 32.5-33 million bpd total OPEC output target in Algiers, which was initially based on secondary industry sources.
Market Validation
(Bloomberg 11/3/16) Brent Rebounds Above $47 After String of Declines
-- Brent, WTI gained, stemming the longest run of declines since Sept. as market seen as underestimating prospects of an OPEC production deal. Dec. WTI +23c at $45.57/bbl at 9:03am ET, rising 1st time in 5 days

Oil prices have been ratcheting down in recent days as doubts build over an OPEC output agreement.

*** But in the last 24 hours or so, a compromise on Iraq’s participation looks imminent, which in turn should clear the way for a credible agreement at OPEC’s November 30 Summit in Vienna on the first cuts in OPEC output since 2008. ***

Briefly, the highlights:

** The key breakthrough is what looks likely to be a Saudi concession to accept an Iraqi quota at their higher 4.7 million bpd output figure they recently asserted as their current output rather than the 4.1 million bpd figure used to formulate the 32.5-33 million bpd total OPEC output target in Algiers, which was initially based on secondary industry sources.

** To help make up the difference, Saudi Arabia is indicating a willingness to cut its output by up to 100,000 bpd on top of the 440,000 bpd on offer in Algiers, or a total as high as 540,000 bpd. With the cuts by Kuwait, the United Arab Emirates, a little from Qatar, and mostly token amounts by the non-Gulf OPEC oil producers, total OPEC output cuts should still be north of 800,000 bpd.

** In a further sign of how badly Riyadh wants a credible deal in Vienna to stabilize oil prices, it has also confirmed a quota exemption for Iran as well as for Nigeria and Libya. It means, in effect, the Saudis are ceding to some degree market share to make room for the Iranian efforts to get back to its pre-sanction levels it puts at just over 4.1 million bpd.

** That said, Iran is already nearing its target pre-sanction levels, while there is not all that much sacrifice in the Saudi cuts, since much of it will represent the run off in the surge to meet summer domestic demand, and the Kingdom is still keeping its output above 10 million bpd mark, which the they consider a floor for now. Meanwhile, Iran will be expected to commit to a hard quota by the time of next year’s June meeting.

** Indeed, the Saudis see Vienna as the first of a two-step negotiating process to get back to a credible OPEC quota system. OPEC’s first real output cuts since 2008 should at minimum put a firm floor under oil prices. And if oil prices rise through the coming months back to the upper end of the implicit $50-$60 target price range, the concessions to Iraq and Iran will have been worth it.

** Ironically, we understand the Algerian-proposed 32.5 to 33 million bpd OPEC total output target was based on an initial Iranian argument their quota should be based on a return to its pre-sanctions output. They put that at a 12.7% share of OPEC’s output in November 2011, which they then asserted translated into a 4.17 million bpd output. The Saudis initially countered 3.6 million bpd was more realistic, but gave up on it, ceding the Iranians the exemption on quotas in Vienna.

** In any case, in the scenario envisioned by the Saudis, firmer oil prices will be boosted, crucially, by an expected tailwind of modestly rising global crude oil demand, and by a Russian follow through on its promise to freeze its own output if OPEC delivered cuts. Russian oil companies are already at record output levels, which the Saudis believe are not sustainable for an extended run without further investments.

** There is, however, a cautionary backstory to the Saudi concessions to make Vienna work, in a perhaps unspoken threat that if this painstaking process to get back to credible OPEC quotas and oil price stability by June fails, the oil policy makers in Riyadh feel they will have no choice but to return to former oil minister Ali al-Naimi’s November 2014 market-share driven strategy. And they do have the spare capacity to do just that.

** If oil prices do swoon again, in other words, the Saudis want to ensure it was not they who were engineering it, thus the best efforts in Vienna and in June to realize the objectives to its shift in strategy underway since early this year. But nevertheless a vindication of al-Naimi could still be on the horizon, perhaps making June even more strategically important of the OPEC meetings than the approaching Summit in Vienna.

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