Three days after oil tumbled following a Bloomberg report that Saudi Arabia was angry at its (N)OPEC co-members for not complying with production quotas, and was no longer willing to compensate for excessive production by other members of the cartel, the WSJ reports that Riyadh, furious that the price of oil refuses to rise, is threatening to boost oil production and unilaterally flood the market if "some" OPEC nations continue to defy the group’s output curbs, cartel officials say.
The surprising ultimatum which reeks of what Saudi Arabia did in November 2014 when it effectively dissolved the cartel, and flooded the world with oil in hopes of putting shale producers out of business only to fail miserably as it never accounted for cheap money and the stupidity of US junk bond investors, comes one day ahead of a gathering between OPEC and non-OPEC nations including Russia on Thursday and Friday in Vienna.
Saudi Arabia, the argument goes, is contending with weak oil prices and members of the cartel who aren’t complying with the collective output cut they agreed to last summer. As a result, the Saudis are considering radical measures, including a new pact that would deepen production cuts although if there is one thing the cartel is notorious for, it is ignoring self-imposed production limits when it suits the individual member states as the Crown Prince is finding out now.
As the WSJ reports, at a technical meeting Tuesday, a Saudi delegate said his government is growing tired of indirectly benefiting the budgets of countries that are flouting the OPEC pact by overproducing oil, said a person who was present. If the noncompliance continues, "the Saudi official signaled that the kingdom would begin merely complying with its commitment—rather than overcutting to make up for laggards in the group." Related: How Much Crude Oil Do You Unknowingly Eat?
The target of Saudi ire are reportedly three specific nations, namely Iraq, Nigeria and Russia; this emerged during a slide presentation by a Saudi official who said the trio of oil-producing nations weren’t adhering to the pact that commits the 14 OPEC nations and 10 allied countries to a collective 1.2 million-barrel output curb.
The stakes for Riyadh are huge: the (N)OPEC spat comes as Saudi Arabia is finalizing the IPO of its national oil company, Aramco, and hopes to bring the company public at the highest possible price, however that also needs a much higher oil price. While the company wasn’t mentioned at the meeting, another delegate said the Saudi position was "all about the IPO of Aramco."
Meanwhile, in a paradoxical twist, with Saudi Arabia raging at Iraq for overproducing, the Iranian neighbor signaled that it, along with other cartel members, favor deepening collective cuts by 400,000 barrels a day. Which of course it is all for... as long as Iraq itself doesn't have to cut further.
Saudi Arabia indicated privately that it would support such a cut if it received watertight guarantees that current laggards would respect the deal, the WSJ said citing people familiar with the matter. What was left unsaid is that the only reason why the OPEC production cut worked as well as it did and as long as it did, is because Venezuela's and Iran's output has collapsed, not because it wanted to but because the two countries had no choice, being subject to US embargo. Related: Meet The Biggest Losers Of The U.S. Shale Bust
In further disappointment to Riyadh, the WSJ gloats that the kingdom "had hoped to keep such option a secret to create an upside surprise in oil prices", with officials instructed to discuss it face-to-face rather than electronically, one person said. Yet following the WSJ report, the price of oil actually slumped amid fears that Saudi Arabia may have no choice but to boost production as it squares off with increasingly hostile cartel members.
The irony: while a new, lower collective target wouldn’t force Saudi Arabia to carry more reductions, as it is already overcomplying, but others would be unlikely do any cutting, OPEC delegates said. The group has also been looking at extending curbs until end 2020 to avoid a glut. There is one other concern: Russia is emerging as a key obstacle to both deeper and extended cuts, according to OPEC officials. Moscow is seeking exemptions from cuts on its gas liquids and failing that, will stick to keeping curbs until March only, the OPEC delegates said.
What OPEC fails to grasp is that the price of oil is no longer determined by the marginal producer but by the secular decline in demand, and nothing OPEC does can boost that.
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Therefore, Saudi Arabia’s threat to flood the global oil market is an empty one. This is a discredited strategy which has been tried in 2014 and found wanting. It led to the collapse of oil prices to under $30 a barrel and inflicted the biggest ever damage on the Saudi economy. (Please refer to my book titled:” What is Behind the Steep Decline in the Crude Oil Prices: Glut or Geopolitics?” which was published in June 2015 by the Arab Centre for Research and Policy Studies in Qatar).
Moreover, Saudi Arabia is already producing just over 10 mbd. It can only raise its production by the 400,000 barrels a day (b/d) it cut under the OPEC+ production cut agreement. Returning 400,000 b/d to the global oil supplies will hardly register on the global oil market’s radar when compared to a current glut estimated at 5 mbd.
Russia will not agree to a deepening of the current cuts since its economy can live with an oil price of $40 a barrel or even less. Moreover, Russian oil companies are against any cuts having invested billions of dollars on expanding their oil production capacity and therefore they need a quick return on their investments.
Saudi Arabia is right to be angry with Iraq and Nigeria for not adhering to their shares of the production cuts. The 400,000 barrels a day (b/d) that the Iraqi oil minister is suggesting adding to the production cuts are equivalent to the volume that Iraq and Nigeria should have cut from their production in the first place.
One option is now open for OPEC+ which is to extend the current production cuts by a few months and hope and for an end to the trade war soon.
Still, all is not lost. One bearish influence currently working for OPEC is the confirmed steep slowdown of US shale oil production as evidenced by the continued fall in oil rig count. US oil production could average under 11 mbd or even less in 2019 and not 12.8 mbd as claimed by the EIA and around 10 mbd in 2020.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Riddle me this, how much longer can this frickin’ nonsense go on?