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Global Risk Insights

Global Risk Insights

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Why An OPEC Production Cap is Unlikely

North Sea Oil

Global oil markets have become volatile once more as the Organization of Petroleum Exporting Countries (OPEC) announced on August 8 that they will hold informal talks during the September meeting of the International Energy Forum in Algeria.

Initial speculation centered on recent moves by cartel members including Kuwait, Venezuela, and Ecuador to re-impose caps on output to force a rise in prices. Acting on this suspicion, Brent crude prices spiked to over $45 per barrel before beginning to settle back.

This initial reaction to the announcement of the September OPEC meeting is premature, however. There are several reasons why it is unlikely any action will be taken by OPEC at the meeting to restrain output. Nevertheless, continued speculation prior to the meeting in late September will likely hold oil prices above $40 per barrel for now.

1. U.S. production higher than expected

On Wednesday, the U.S. Energy Information Administration (EIA) reported that U.S. production will fall from 9.3 million barrels per day in 2015 to 8.73 million barrels per day in 2016. This production estimate, though, was revised upward from their original forecast of 8.61 million barrels per day for 2016.

The rise in expected U.S. output comes on the heels of higher oil prices through the spring and early summer. With prices climbing over $50 per barrel in June, there was a significant uptick in new drilling rigs which have come online over the past 6 weeks. New output from these rigs should begin to stabilize U.S. output by the fall.

These revised numbers will certainly make OPEC action to cap output less likely during their September negotiations. OPEC has recently opposed limiting output in part to keep prices low enough to discourage significant new production in the U.S.

In this way, OPEC has already made the strategic decision to maintain their approximately 40 percent share of global output rather than to allow prices to rise and encourage new market entrants outside the cartel. With new rigs drilled as a result of a relatively modest rise in the price of oil, capping output in September would run counter to OPEC’s longstanding strategy.

2. Iran capitalizes on sanctions relief

Following a U.S.-Iranian agreement on nuclear development, a host of long-standing, international sanctions against the country are being lifted, freeing Iranian energy markets to international investment. Iran has already begun negotiations with several firms interested in development of the country’s energy infrastructure, including Siemens and Rolls Royce.

As Iran continues to integrate its energy exports into a wider global market, it has expressed little interest in supporting an OPEC-led reduction in output. While direct engagement between U.S. companies and Iranian oil infrastructure remains complicated, sanctions relief will prove a windfall for production and revenue generation.

At the April OPEC meeting, Saudi Arabia stated that it has little interest in curbing production without support from Iran. As it is unlikely that Iran’s interest in developing its infrastructure following the deterioration of the sanctions regime will abate by September, their opposition will prove another impediment to curbing output.

3. Global increase in demand

In its August report, OPEC updated its estimates for global supply and demand. The Organization now projects global demand will increase by 1.22 million barrels per day, 30,000 barrels per day higher than last month, to 94.18 million – largely driven by India and a rise in demand in the United States. Concurrently it anticipates non-OPEC production will fall by 790,000 barrels per day widening the demand gap.

Capping output at this time would jeopardize OPEC’s ability to capture this anticipated supply shortfall, driving prices up and encouraging increased output from non-OPEC countries.

By Jon Lang via Global Risk Insights

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