Leaders from OPEC and some non-OPEC member nations converged on Vienna, Austria this week for their annual summit to discuss crude oil output. The meeting delivered an agreement to cut overall OPEC output by 1.3 million barrels per day to 32.5 million barrels per day, down from record October 2016 output of 33.8 million barrels per day. Rumors of cuts have been circulated by the organization during much of the current oil price slump, each time attracting bullish bets in the market which, until now have been batted down with each promise of production cuts that didn't come to fruition. This time around, world oil producers gave teeth to the rumors, and actually implemented a plan to rebalance price-negative world supplies. A casual glance at the headlines would give one the impression that a major move has been made, but when we look at the details, we gain insight into why a deal was so difficult to make, and we are left wondering if the cuts will significantly reduce world oil stocks and support a sustained recovery in the oil market.
There was a lot more on the table than just oil. Since economic sanctions against Iran were lifted, that nation has been anxious to recapture the marketshare they lost during the sanction period. The Sunni/Shiite conflict of the ages muddied those waters with previous attempts to make a deal hinging on a "you cut first" attitude between Sunni Saudi Arabia and Shiite Iran. There has been bad blood between Sunni and Shiite Muslims going as far back as the death of Mohammed when both sects of traditional Islam argued over which ideal was the true expression of Mohammed's vision of Islam.
In more modern times, the Sunni/Shiite dispute was exacerbated by the invasion of Iraq and the subsequent departure of American forces which had toppled Saddam Hussein's Sunni regime and replaced it with the Shiite leaning Nouri al Maliki. That angered Iraqi Sunnis, and indeed Sunnis around the Middle East, giving rise to domestic terror cells including ISIS. The divide between Sunni and Shiite Muslims runs very deep and is based in Islamic ideology, and the words of the Qur'an which impress upon its readers the need for societal and religious domination (Qur'an 9:5). Since the time of Mohammed's passing, Sunnis and Shiites each have believed they have a monopoly on the true Islamic tradition thereby making apostate heretics of followers of the opposing sect. (This is a crude, tertiary rendering of this complex ongoing conflict, but highlights the difficulties the religious dynamic adds to coming to an agreement.) That made it very complicated for the two sides to come together and agree to cooperate by managing crude oil output in the region.
It was against that backdrop, and in the context of declining national revenues in Saudi Arabia and non-OPEC member Russia that Vladimir Putin reportedly entered the conversation and helped bridge the gap between Iran and Saudi Arabia. Leading up to the announcement of the deal, it was said that both Saudi Arabia and Iran were notably quiet, placing religious squabbles on the back burner in order to arrive at an agreement. That agreement allowed Iran to actually increase crude production by 90,000 barrels per day, but placed a hard cap on allowable Iranian crude production. Saudi Arabia was willing to take the largest cuts in raw barrels, but by percentage, all member nations agreed to a roughly 4.5 percent cut to daily production based on the October 2016 production figures. Iran was the only attendee that was allowed to increase production to levels seen before sanctions had been placed on that country which, by percentage, translate to a 0.05 percent increase in daily output.
For its part, crude oil powerhouse Russia was assigned a 300,000 barrel per day production cut, down from August 2016's 10.3 million barrels per day. Prior to the agreement, Russian oil officials had been planning to increase output in 2017 and many industry watchers are skeptical that non-OPEC member Russia will be true to the OPEC-led agreement. Long time Inputs Monitor readers will recall the Russian/Belorussian potash production strategy which favors marketshare over price, pummeling retail potash prices and swelling world inventories. If Russia's handling of potash production is any indication of how they will proceed, expect Putin to ignore the Vienna deal, and continue to vie for crude oil marketshare.
Meanwhile, U.S. producers wait in the wings for WTI prices to climb back to a profitable level. In fact, as prices have firmed in response to the OPEC rumormill in recent months, U.S. rigs have begun to come back online. It has been shown that low prices will drive U.S. rigs counts down, and there is nothing in this agreement that remedies that reality.
The agreement forged in Vienna this week has been long awaited and brought long time religious rivals to the table peacefully. But the very fact that the biggest hurdle in creating an amicable arrangement was between Saudi Arabia and Iran ignores the devastating impacts of falling crude oil bids in other venues like Venezuela and Ecuador. That may mean that compliance will be an even bigger hurdle for Sunni and Shiite partners and if Saudi Arabia or Iran decide to ignore the deal, those countries who actually do comply will lose marketshare, compounding economic woes like those playing out in Venezuela. Add to that the potential for U.S. production to resume, this time with many oilfield services and operations under new, more efficient management which can profit at sharply lower levels than from just a year ago, and OPEC could be in a bit of a pickle. Any production cuts will be quickly answered if not by Russia, then certainly by the United States. That would swell world stocks, pressure crude futures prices and put us right back to where we started.
Time will tell if the agreement will stick. Long-held religious rivalries, Russian volume over price strategies and refreshed drilling activity in the United States will all have to stay on the back burner for world stocks to drawn down significantly. The more likely scenario is the deal holds up just long enough for Saudi Arabia to realize they are among the few who agreed to cuts that are actually curtailing production. As Saudi Arabia's oil revenues have declined, so has their influence over the loose conflagration of oil producing nations called OPEC. If the market allows U.S. and Russian drillers to produce oil with impunity, OPEC members will have to decide between honoring the agreement made this week, or continue to produce at high levels into a world crude oil oversupply.