This morning’s headlines of Saudi Arabia’s threat to raise output and the quick denial by OPEC Secretary General Mohammed Barkindo should be taken for what they are: the usual OPEC pre-meeting posturing and brinkmanship.
*** We do think an OPEC agreement in Vienna to cut output, based on some form of quotas or “allocations” is more likely than not (SGH 9/23/16, “OPEC: Towards a November Output Deal”). It is founded on our sense of how badly Saudi Arabia wants an agreement to stabilize prices, ideally with a floor around the $50 mark, and how far they are willing to go in concessions and output cuts to get there. We understand there are now some 800,000 bpd of output cuts on offer from the Kingdom and its Gulf allies. ***
*** But an OPEC agreement in Vienna is ultimately only possible if the Saudis keep the threat of increasing output on the table, and likewise, only if the other oil producers, especially Iran and including Russia, believe this OPEC version of Mutually Assured Destruction is plausible. So we would expect plenty more similar shock headlines between now and November 30 to ensure the compromises and concessions needed for a reasonably credible agreement. ***
It is just how OPEC works.
Output Cuts on Offer
To put an agreement in Vienna within reach, the Saudi threat has to be real, and at least in terms of the Kingdom’s current spare capacity, it is real: the Kingdom has, for instance, kept the 500,000 bpd or so of potential output from the Kuwaiti-shared Neutral Zone fields shut in for quite a while now, and it is intended more or less as a sword to hold over Tehran to coax adherence to a minimum of cooperation.
But the emphasis should be as much on how badly the Saudis want an agreement in Vienna as the credibility of their threat to swing output the other way. Their reasons are more strategic now — in terms of underpinning their ambitious plans to transform the Saudi economy and turn to investments and accessing the international capital markets — than just a scramble to plug budget deficits (see SGH 5/9/16, “Saudi Arabia: The Emerging MbS Doctrine”).
And the likelihood the Saudis will increase their offer of output cuts made in Algiers should not be undervalued. With the additional cuts from Kuwait and the United Arab Emirates, the Kingdom and the Gulf are putting some 800,000 barrels of cuts on the table. With the cooperation of other members, that number could perhaps even hit a hard to achieve but headline-pleasing one million bpd in OPEC output cuts.
What’s more, Riyadh already made major concessions in Algiers and, as we reported yesterday (SGH 11/2/16, “OPEC: Vienna Deal Looks Likely”), has indicated to the Iraqis a willingness to at least work with their claims of a higher output figure in order to keep them on board.
Risk-fraught Negotiations with Iran
The negotiations with Iran are always the most contentious and risk-fraught of the bilateral concessions needed to underpin the broader OPEC agreement. And on this front, Saudi Arabia has already conceded, somewhat surprisingly, an exemption to Iran on a hard quota in Vienna.
There is some dispute where the current Iranian output truly is, or how sustainable it will be in reaching its pre-sanction target of a little more than 4.1 million bpd. But for now, it is our understanding the Kingdom will be willing to essentially look the other way on the Iranian efforts to hit their target. But at minimum, Riyadh does want, and expects, Tehran to accept a hard quota no later than at the OPEC meeting next June.
In that sense, Iran is being granted a time-sensitive “partial” exemption in order to win over its adherence to a Vienna framework deal, but with a clock ticking on a deadline come next summer.
In framing their negotiating stance with Tehran in that way, the Saudis are hoping to step back from their clumsy approach to the “freeze” negotiations last spring that spectacularly fell apart in Doha (SGH 4/17/16, “Oil: Doha Collapse”). This time, Riyadh is hoping to position the burden and any blame for another collapse on Tehran.
Riyadh’s “Two-Step” Strategy
This implied threat of ramping up output is also where Riyadh’s “two-step” approach to securing a return to viable OPEC quotas enters the negotiating framework. The Saudis are willing to make substantial cuts in output at the Vienna Summit for a minimum of concessions from the other OPEC member states in return.
But if whatever comes out of Vienna fails to stabilize prices, or there is an excess of cheating or ignoring the commitments made in Vienna, then there will no doubt be far fewer compromises on offer by the time of the June OPEC meeting. The threat to resume a market share-driven oil strategy would by then become much more real.