Output freeze taken with a pinch of salt

Saudi Arabia, Russia, Venezuela and Qatar struck an agreement in Doha on 16 February 2016 to ‘freeze’ output at January levels, conditional on other producers within and outside OPEC joining in. However, the news was shrugged off by the markets, even as crude prices have recovered from a 13-year low, writes Vandana Hari, Asia Editorial Director Platts and Research Scholar, McGraw-Hill Financial Global Institute.

Without broad support amongst producers, the agreement appeared to amount to no more than jawboning and wishful thinking. Anything short of a substantial production cut – at least by 1.5–2mn b/d – is too little too late to arrest the current low price environment which results from growing stockpiles, jitters over the Chinese economy, and doubts over global oil demand growth since the start of this year.

Even an agreement to rein in output and agree a lower collective ceiling would be taken with a pinch of salt, given that OPEC no longer has individual member quotas, the organisation’s poor track record of compliance with output cuts, as well as non-OPEC producers failing to keep to their committed reductions through history. Significantly, a sanctions-free Iran, which is aspiring to boost output and exports by at least 500,000 b/d towards the end of its current fiscal year on 19 March, offered nothing but platitudes in response to the deal while Iraq, currently OPEC’s second largest producer and hitting new record highs with its output, still needs to be persuaded.

Nonetheless, it might be too early to dismiss the move as completely inconsequential. If Saudi Arabia indeed freezes its output at January levels, it could mean a cut of around 500,000 b/d in the Kingdom’s exports in summer, when it normally ramps up production by as much as 750,000 b/d from January levels to fuel domestic power production in the hot season, according to data from the Riyadh-based Joint Organizations Data Initiative. This pact might just give Saudi Arabia, traditionally the main swing producer, a face-saving way to start dialling down production without seeming to be taking a U-turn on the controversial market share policy it pushed through OPEC in November 2014.

If Russia, Venezuela and Qatar follow suit, the light will shine more intensely on the major OPEC and non-OPEC producers that continue to pump full tilt, possibly prompting some to fall in line, or at the very least, give the Saudis the moral authority to argue for a ‘January-level freeze’ across the board at OPEC’s June meeting.

An OPEC/non-OPEC pact, coupled with a sharper slide in US tight oil production than the 700,000 b/d drop in 2016 to 8.69mn b/d from 2015’s average currently forecast by the US Energy Information Administration might just amount to the tipping point that starts rebalancing the markets in the second half of this year.

It is often argued that any recovery in prices from a rebalancing market would bring the US tight oil producers right back. That’s actually much more nuanced – the seeds for the burgeoning US production we have seen in the past few years were sown in a period of relatively stable and high crude prices around $100/b over 2011 to mid-2014, after the global financial crisis. Any production that would return in response to higher prices could be far more gradual, and cascaded, with smaller corrections along the way so that the world doesn’t end up in a massive glut again.