Without Iran and Iraq, the decision to freeze production level makes little sense
Suparna Goswami Bhattacharya
March 4, 2016: It is too little action and taken too late. This is what experts have to say about the decision by Russia, Saudi Arabia, Venezuela and Qatar to freeze oil production.
For the uninitiated, representatives of Russia, Qatar, Saudi Arabia and Venezuela met on February 16 and took the decision to freeze oil production at January level. In fact, this is the first coordinated move by the world’s two largest producers to counter a slump that has pummeled economies, markets and companies. It also happened to be the first effort at coordination between OPEC and non-OPEC producers in 15 years.
However, the market has not reacted as per expectations. And experts are not surprised. “The impact of any agreement between oil-producing countries regarding production freezes will be somewhat muted due to the overwhelming stockpiles. Had this deal come at some point last year, before energy administrations reaped the benefits of low oil prices, there would likely be more impact on markets,” says Robert Hill, economist at FocusEconomics.
What has happened now is that the stockpiles will act as a buffer, insulating the markets from the effect of any production freezes, for at least several months. In this sense, the deal between oil producing countries is too little too late.
Ildar Davletshin, who heads oil & gas research at Renaissance Capital, says Saudi Arabia made the mistake of underestimating the US. “I guess they did not see the pace at which the developments were taking place at US shale reserves and, hence, responded at a late stage. The technological progress has been at full swing and now it is too late to stop it quickly,” says Davletshin.
According to John Hall, chairman, Alfa Energy, Saudi Arabia has its own reasons of acting late when it came to freezing oil production. In 2008 when the world was going through a recession, oil prices came down. However, in 2009 speculation in the market that economies are now recovering led to recovery of oil prices as well. This led to prices touching figures higher than $100 per barrel.
“They were warned at the time that an unnaturally high oil price would firstly, inhibit recovery of the world economy, leading to demand destruction. Secondly, it would encourage energy conservation and we have seen this, particularly in the distribution sector. Thirdly, it would encourage the development of alternative energy sources, such as oil and gas from shale, and this from the US has been the real game changer for the market,” remarks Hall.
However, OPEC did not pay heed to any of these suggestions. They cut back on their output thinking it will lead to a further rise in prices and countries will continue to buy from them.
This is when non-OPEC producers like Russia and the US quickly moved in and took their market share.
Data from the International Energy Agency indicate that there had been an oversupply of 1.8 million barrels in Q4 2015.
Economists say that Iran and Iraq can produce enough oil to easily counter the production freeze pact. Marco Wagner, economist at Commerzbank, says Iran needs to export as much oil as possible to improve their economy financially. “To be honest, Iran faces a huge backlog. Due to the sanctions, it was not able to produce and export oil to a great extent, which put massive pressure on its public finances and economic growth,” he explains.
Though Venezuela’s oil minister has stated that the pact could boost prices by 10 to 15 USD per barrel, experts term the statement fairly optimistic. On February 23, the Iranian oil minister essentially undermined any tentative deal between producers by stating that Iran’s upstream and midstream facilities were just coming online now and that any freeze at its current production rates would be out of the question.
“Without all producers on board, there can be no deal, as no one producer wants to risk losing market share. Given that relations between Iran and Saudi Arabia are as icy as ever, it does not seem likely that a proposal nor even enforced production freezes or cuts are on the horizon,” says Hill.
Against this backdrop, and considering the difficulties in creating a binding agreement amongst oil producers, there does not seem much that OPEC, or any one country, can do to boost energy prices. Prices will climb as decreased investment in energy production narrows the gulf between demand and supply. However, producers in the United States and Canada, which are not controlled by OPEC or a national oil agency, will turn the taps back on in the shale fields and tar sands once prices reach profitable levels, essentially placing a ceiling on crude prices.
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