The Future Of OPEC Is Underground

Roughly two years ago, in the last days of November 2016, Vienna became the epicenter of global oil developments. There, a ground-breaking agreement was concluded, the Vienna Agreements (also known as OPEC/OPEC+), which were crucial to the stabilization of crude markets that occurred afterwards. In a way, all the oil producing nations that managed to bounce back into profitability and overcome the severe hardships of the drastic 2015 price fall owe their success to the Vienna agreements. Now, Vienna is once again the capital of the oil world - two rounds of consultation took place there this week, first between OPEC member nations, then with the inclusion of OPEC+ members within the framework of the Joint Technical Committee, co-chaired by Saudi Arabia and Russia.

The two-day Vienna summit was an emotional rollercoaster - starting with high hopes, it quickly transformed into a dreary spectacle, only to bring forth an unexpected deal. Initially it seemed that the Saudi Energy Minister Khalid al-Falih will be able to ram through a deal within OPEC and then the only issue to sort out would be Russia's contribution. Much of the speculation thereafter has focused on Russian Energy Minister Alexander Novak flying back to Saint Petersburg, allegedly to consult the cuts with President Putin, and Russian reluctance to commit to a 300kbpd production cut. Everything was ready, it seemed - the baseline month (October), the overall cut level (after lengthy discussions all the sides adopted the 1mbpd as a target), yet eventually the negotiation process was distracted by the usual source of intra-OPEC conflict, antagonism between Iran and Saudi Arabia.

These hassles are not to understate the fascinating transformation OPEC has gone through in the 2010s. After the December 2011 Vienna meeting OPEC did not convene top-level summits for 4 years, largely on the back of Saudi Arabia walking off from the traditional quota distribution system and scrapping any sort of aggregate OPEC production limits. Inevitably, since Saudi Arabia is pretty much the only OPEC member that can calibrate its output depending on market conditions - the others produce as much as they can, not as much as they wish - Riyadh's actions marginalized OPEC as a decision-making authority. It is almost unbelievable to realize, perceiving it from a present-day perspective, to what extent did the OPEC+ deal revitalize OPEC and bring it back from the dead-end it was headed for.

Yet the powers of history might bring OPEC back to square one and turn it into an assembly of squabbling, mostly Middle Eastern nations, with Saudi Arabia ramming its decisions through under the guise of their mutuality. Saudi Arabia itself is entrapped in a triple dilemma - it wants to keep OPEC a viable solution in case markets turn to oversupply or vice versa, it genuinely wants to build a new strategic partnership with Moscow (the only superproducer apart from Riyadh that is ready to take part in output cuts) and it wants to maintain a healthy relationship with the United States. The latter has become quite problematic recently as any production cut immediately entails a Twitter response from President Trump, blaming Riyadh for hiking fuel prices, and only output increases raise laudatory tweets.

The Russian political leadership cherishes the prospect of deeper cooperation, yet cannot take up an immediate commitment. In the words of LUKOIL CEO Vagit Alekperov, Russian companies would gladly join the output cut, yet because of the cold weather it would be easier and safer for them to do so once the cold winter ends. Traditionally, Russia's oil production is the lowest in March-May when the thawing of ice and the onset of more volatile climatic conditions encumbers transportation from and development of the field. The same mood is to be found generally with CEOs of Russian majors - they say that an output cut is necessary and are happy to comply with any decision of the Energy Ministry, albeit with a proviso - from spring.

Russian involvement in OPEC cuts is still heavily tilted towards the non-performance of obligations. The first time Russia took place in an OPEC-led production cut was in 1998, when against the background of financial turmoil in Asia (and the Russian bankruptcy crisis), the Boris Yeltsin-led Kremlin administration pledged to a 7 percent cut, which at that time would have translated into decreasing annual output by 20 million tons from an aggregate of 303 million tons. Despite its vows, Russian oil companies did the exact opposite, increasing annual production in 1999 to 306 million tons, whilst Saudi Arabia cut 650kbpd of it. This might be explained by the erratic character of Russian foreign policy under President Yeltsin, however, the second case of inobservance occurred already under President Putin in 2001.

In September 2001, amid 9/11-induced panic on the market, OPEC members agreed to scrap 1mbpd worth of production from the market and Russia agreed to participate in this by committing to a relatively modest 50kbpd cut. And again, against the background of Riyadh cutting output by 300kbpd, Russian oil companies effectuated a real tour de force. Russian companies increased production by a spectacular 650kbpd year-on-year, bringing it to a then-record level of 7.8mbpd. Russian ministers stated they could not impose the production quota as the companies bypassed the state-owned pipeline transportation monopoly Transneft's system and chose to transport the surplus volumes by rail to their final destination or port.

Yet the Russian problem is by no means an unsolvable one - since Saudi Arabia wanted a longer-term quota system which runs until at least Q3 2019, a piecemeal solution whereby it cuts production first and then Russia joins in at a later stage is still be better than nothing. According to first reports Russia is to commit to a 0.2mbpd cut (out of the 0.4mpd allocated for OPEC+ reductions), thanks to a last-minute consensual role breakdown Iran and Saudi Arabia would make up the largest part of OPEC's 0.8mbpd cut. There has been very little talk of OPEC+ commitments apart from Russia, in case Oman, Mexico or Malaysia can carry it into effect, the overall OPEC/OPEC+ commitment level would amount to 1.2mbpd - a result deemed impossible after Thursday's series of stalemates.

Despite the successful ending, what has become obvious, at least for your humble narrator, is that the future of OPEC/OPEC+ lies somewhere underground - the excessive media coverage of every step OPEC takes as an organization hurts its maneuvering space and is sowing bad blood within the so-called cartel. It is for a reason that when mooting the creation of a new super-OPEC including Russia, Riyadh has deliberately tried to pass the buck to Moscow, claiming it should take helm over the nascent (albeit charterless and unmanned) organization given Russia's bigger geopolitical clout. On the other hand, Moscow would never accept this - amid Syria, Ukraine and a plethora of smaller proxy conflicts with Western powers, primarily the United States, the last thing it wants is to hand out another lever of criticism.

Yet there is an organic push for more cooperation between the world's second and third largest producers. Institutionalizing Saudi-Russian partnership would anger traditional OPEC members, reproaching Riyadh for marginalizing them in favor of a bigger market player. Moreover, creating another structure (even if it were without administration, staff or a headquarter) would repeat the mistakes of OPEC - decisions too important to be flaunted freely in the public ether would be once again openly discussed. Against the background of rapidly rising oil production in the United States, which has created a sort of scapegoat for everything that is adverse and oil-related, digging the Moscow-Riyadh axis deep below the ground, where no one sees it, suits the interests of both.