Once again, oil will be in for a wild ride this week as rumors continue to swirl that OPEC and non-OPEC producers may be warming to the idea of production cuts – or at the very least, a freeze at current levels. As much as traders, oil producers, and investors want this to be true, the facts say otherwise.
The producing countries that matter most in the oil market right now are Saudi Arabia, Russia, and Iran. None of these producers have any incentive to cut production, which is why news of potential production cuts is primarily wishful thinking.
Saudi Arabia has the second largest proven oil reserves in the world (only a few billion barrels less than Venezuela) along with the strongest financial standing and the best-run national oil company (Saudi Aramco). When it comes to setting policy in OPEC, Saudi Arabia and its oil minister, Ali al-Naimi, have outsized influence. Saudi Arabia believes its policy of high production levels is working – which it is – for Saudi Arabia.
Russia has only about 80 billion barrels of proven oil reserves, putting it at just 8th in the world, behind the UAE. However, Russian oil production is currently running at full capacity, putting its output on par with Saudi Arabia. Even though Russia is not an OPEC member, its extremely high production levels make the country even more influential in the current oil market than OPEC producers with greater reserves.
Iran is in the opposite position from Russia – the country has the third largest proven oil reserves but extremely low production levels due to years of economic sanctions. Right now, Iran’s power to influence the oil market comes from its potential to grow production since sanctions have been lifted. Iranian predictions should not be believed, considering the poor state of its oil facilities and its inability to attract the foreign capital needed to rehabilitate them, but Iran has enough productive capacity such that it could quickly fill any gap in the oil market left by an agreement other producers might make to reduce production.
Saudi Arabia knows that any OPEC-orchestrated production cuts will only harm Saudi Arabia and help Iran, Russia, and the United States. Production cuts from OPEC countries would quickly be filled by Russian or American oil production. This would hurt Saudi Arabia in the long run, because the downward pressure on prices would continue and Saudi Arabia would lose out on market share. Saudi Arabia has no reason to trust Russia and Iran – both from past experience and because of current leadership.
Russia continues to pump because it needs any money it can get and because it needs to cement its new relationship with its largest new customer – China. Iran needs unfettered production and sales once its oil infrastructure is rebuilt in order to reclaim its pre-sanction customer base. Thus, the powers that make the decisions lack the incentive to decrease production. The only foreseeable reasons they might agree to decrease oil production are:
- Saudi Arabia might be enticed to entertain production cuts if it is convinced that it can trust Russia and Iran.
- Russia could be feeling the limits of its aging oil fields and realize that current levels of production are unsustainable. Russia would be in a better position geopolitically if it looked like it agreed to production cuts rather than was forced into them. This could be the evidence Saudi Arabia needs to trust that Russia will follow through this time around.
- Iran may be coming to the realization that it cannot attract the foreign investment it needs to fix its oil infrastructure when oil prices are so low. The internal political opposition to getting these contracts done is still considerable, but as long as it does not seem like Iran was forced into agreeing to cuts, the pragmatists may be able to convince the hardliners. Whether Saudi Arabia can, or will, trust Iran is still a major question.
Another wildcard is the United States. American startup producers – no longer restricted by the oil export ban – could and would simply ramp up production and fill in the production gaps left by any OPEC and Russian cuts. These American producers could not participate in any coordinated production cut (unless granted anti-trust immunity beforehand), nor do they have any incentive to do so. Saudi Arabia may still not be convinced that the prolonged period of low prices has sufficiently damaged these start-up producers to implement cuts at this point.
Why, then, are they meeting? Ali al-Naimi has been very clear that he is willing to discuss market conditions and production cuts with major non-OPEC producers – like Russia – for some time. But remember, discussion does not mean action.
(Source : Article in Investing.com)