With crude oil prices dipping below $50 a barrel for the West Texas Intermediate benchmark, market speculation is again turning to the levels of compliance and the odds on an extension of the OPEC-non OPEC oil output agreement reached last November in Vienna.
*** It is our understanding Saudi Arabia is highly likely to extend its 538,000 bpd of output cuts under the terms of the Vienna agreement when it comes up for review at the ministerial meeting in late May. That extension will be contingent on the non-OPEC producing countries, including Russia, and the other OPEC producers, especially Iraq, bringing their compliance fully in line with the agreed output cuts by the time of the technical committee review in mid-May. ***
*** The Saudis will be further willing to trim output below their current 9.8 million bpd, by another 40,000 to 70,000 bpd, if needed, over the summer to keep oil prices from slipping below a $50 floor. Resigned to US shale output in effect capping crude prices at no higher than $60, Riyadh is instead eyeing a $55 average as the equilibrium price that should bring global supply and demand into balance sometime in the second half of this year. ***
A Crucial Riyadh-Moscow Alliance
Saudi confidence in oil prices stabilizing above the $50 floor is largely built on Riyadh’s deepening strategic alliance with Moscow on oil policy and on the Mideast regional developments, a relationship the Saudis have been methodically nurturing through all of last year (see SGH 2/19/16, “Oil: An Output Deal and the Riyadh-Moscow Axis”).
That Russian energy minister Alexandar Novak joined his Saudi counterpart Khaled al-Falih in a press conference on the sidelines of this week’s energy conference in Houston was telling.
More importantly, Russia is no longer hanging back to see how OPEC manages its oil policy but is increasingly integrated into and leading OPEC oil policy alongside Saudi Arabia as the two key global oil powers.
Russia’s Novak, for instance, co-chairs with the Kuwaiti oil minister Essam Al-Marzouq, the OPEC-non OPEC compliance committee, which will next meet in Kuwait on March 26 to review the levels of compliance among the 26 participating oil producers through mid-March.
The Kingdom, through its Public Investment Fund, and Qatar, have both also made major investment commitments to the Russian energy sector.
Cuts by many oil-producing participants to the Vienna agreement, including Russia, have been slowed by maintenance cycles and weather. Russia has to date trimmed output by perhaps 118,000 bpd, or a little over a third of its target 300,000 bpd in cuts under the terms of the Vienna agreement. But Novak reassured al-Falih that another 40,000 bpd in cuts was coming “soon” and that Russia will be fully compliant with the targeted 300,000 bpd in cuts by the May 25 OPEC ministerial meeting in Vienna.
Another key oil producer, Iraq, has only managed to cut its output by barely 85,000 bpd compared to its promised cuts of 210,00 bpd. But the Iraqi oil minister Jabar al-Luaibi, who also attended the energy conference in Houston, insists that his country at at around an 85 equivalent of the cuts in the level of exports, and has promised to hit full compliance by the time of the May ministerial meeting. Similar production commitments to compliance have come from Abdu Dhabi, another key Gulf ally.
The next key meeting will be in the technical committee review of compliance levels in mid-May, followed by the full ministerial OPEC-non OPEC meeting in Vienna on May 25, when the November output agreement will be considered for another six-month extension.
Chinese Intermediation and Iran
The Saudis are also encouraged by the likelihood that Iran will accept an end to its exemption from the November quota agreement and to cap its output at around its current levels of 3.6 million bpd. The Iranians have found it very difficult to push their output much beyond current levels.
What’s more, there is some thinking in OPEC circles that Tehran may feel more cooperative on a hard quota cap by the time of the May 25 meeting. That is because Washington under President Donald Trump may re-impose or continue to threaten to re-impose US sanctions, which could make it even more difficult for Tehran to find the investment and technology to boost its oil field output.
Saudi and Iranian relations and the inability to reach agreement on oil policy has been severely limited, to say the least, perhaps reaching its low point in the Doha debacle in April last year (SGH 4/17/17, “Oil: Doha Collapse”).
Chinese president Xi Jinping, who will meet with Saudi King Salman bin Abdul Aziz next week in Beijing, is expected to affirm his willingness to intermediate once again between Riyadh and Tehran to help resolve differences, as he did in January last year that played a crucial role in opening the door to the initial Saudi efforts to stabilize oil prices through an output freeze (See SGH 1/19/16, “Oil: China to Lower Production, Raise Imports”).
President Xi will also make a commitment to purchase at least 50 million tons of crude from the Kingdom in 2017, or an average of 100,000 bpd. While not a huge amount, it is a reassurance of Chinese purchases that will not be going to Riyadh’s chief rivals in the China market, including Russia, Iran, and Kuwait.
The Kingdom’s Domestic Restraints
Despite the implied threat of a return to the November 2014 market share strategy if the other OPEC and non-OPEC oil producers fail to comply with their promised output cuts, the Saudis are in fact limited by how much they can endure a bout of oil market instability, much less another collapse in oil prices.
For one, the Saudis need the oil revenues. While Riyadh is not hurting as much as other oil producers, it still needs to maximize its crude oil revenues while it undergoes the dramatic economic transformation that entails among other changes a shift to new state revenue through investment income and other sources of non-crude oil revenue like petrochemical sales.
And another critical driver to the Saudi oil policy to keep oil prices reasonably stable and above $50 and around that $55 equilibrium price benchmark is to provide the ideal financial and economic backdrop to its ongoing bond issues — the current financial planning entails some $20 billion a year over the next four or five years — and its eventual partial IPO of Saudi Aramco.
Saudi oil policy officials are highly reluctant to return to the November 2014 market share strategy that was implemented by former oil minister Ali al-Naimi, which they now consider to have been a failure.
Instead, the thinking in Riyadh is to find ways to potentially cut oil output further if it is needed to shore up oil prices and assuming the other oil producers are sharing the burden in output cuts.
While there are limits to output cuts much below the current 9.8 million bpd in output, there may room for further output cuts through lower domestic energy demand. This year’s budget introduced a gradual phasing out of heavily subsidized electricity and gasoline prices.
Some eleven million Saudis have signed up for financial help in meeting their higher energy bills, a far higher number than anticipated. But Saudi officials believe the higher energy prices could reduce the 2.8 million bpd of output going to meet domestic demand by 500,000 to as much as 750,000 bpd by this time next year.