• STRATFOR ANALYSIS

    OPEC’s attempt at rhyme and reason

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    After two years of squabbling over how to respond to low oil prices, OPEC has finally arrived at a solution. At its meeting on Wednesday, the cartel resolved to cut production for the first time in eight years. Beginning Jan. 1, OPEC’s members will collectively reduce their production, based on October levels, by around 1.1 million-1.2 million barrels per day, with Saudi Arabia, Iraq, Kuwait and the United Arab Emirates bearing the brunt of the drawdown. The deal, which has been under discussion since September, also aims to reduce production outside the bloc by 600,000 bpd. (Russia has already committed to take 300,000 bpd out of production, and OPEC is set to negotiate similar arrangements with other non-members in Doha, Qatar, on Dec. 9.) News of the prospective cut sent oil prices soaring almost immediately: Brent, the global benchmark for light sweet crude oil, jumped 8.54 percent on Wednesday, hitting $51.36 per barrel. Perhaps more important, the agreement demonstrates that for all its divisions, mutual distrust and weak enforcement measures, OPEC can still work together when the need arises.

    The biggest stumbling block in negotiating the agreement was the bitter rivalry between two of the bloc’s most prolific producers, Iran and Saudi Arabia — neither of which would yield to the other’s demands. But even they can leave Vienna satisfied with the arrangement. Despite the great pains it required to reach, the deal does not represent a significant shift in strategy for either country.

    When oil prices began their steady descent from a peak of $115 per barrel in June 2014 to a dismal $27 per barrel in January 2016, Saudi Arabia responded by boosting production to increase its market share overseas.
    Between December 2014 and July 2015, production in the country swelled from 9.5 million bpd to 10.6 million bpd, and this year, its exports increased by 446,000 bpd from January to August. Even though Saudi Arabia agreed to curtail its production by 486,000 bpd for the duration of the six-month cut, it does not have to give up its exports. In fact, its share of the global oil market will shrink only marginally, at least for the first few months that the deal is in effect. To persuade other countries to cut production, Riyadh threatened to keep producing at its summer levels, which reach staggering heights to satisfy surging domestic demand for power generation. Because many other OPEC producers do not experience the same seasonal swings in demand, their share of the cut will come out of their exports.

    The deal also accommodated many of Iran’s demands. Riyadh talked Tehran into capping production at about 3.8 million bpd under the deal, but, at the same time, it recognized Iran’s ability to produce at pre-sanctions levels. And though Tehran did not walk away with the production quota it was hoping for — as Libya and Nigeria did — it still secured official permission to increase its production. (Meanwhile, its rivals in the Gulf Cooperation Council will have to cut back.) This victory will enable President Hassan Rouhani and Oil Minister Bijan Zanganeh to return home without fear of criticism for “self-sanctioning.” In addition, Iran’s oil industry will be able to ramp up its production while reaping the benefits of higher prices.

    Agreeing to cut production and cutting production are two different things, of course. As with any deal, each party will likely try to bend the rules to its advantage. Kuwait, Algeria and Venezuela will be responsible for monitoring their fellow member countries to ensure compliance, but it is doubtful that the production cuts will ever reach their intended level. Furthermore, though decreasing production will help the oversaturated market regain its equilibrium more quickly, OPEC is under no illusion that it can control global oil prices as it once did.
    In the more than 55 years since the cartel’s founding, the oil market has changed drastically, thanks in large part to the rise of North American production.

    Even so, the agreement shows that OPEC, a bloc comprising geopolitical rivals, is no more divided today than it ever was. Changing market conditions have not prevented OPEC’s members from collaborating to respond to them collectively. Instead, they have merely changed the circumstances required to bring the bloc together — and for the past two years, the threshold for cooperation has been far higher than in previous oil slumps. In striking its latest deal to curb production, OPEC faced many of the same challenges that it has encountered in previous efforts to compromise. Mana Saeed Oteibi — then the United Arab Emirates’ oil minister — summed up a similar struggle over a 1983 production cut in verse:
    The price of oil is falling down. Reduction does now look inevitable.

    So let us discuss clear quotas, though discussions may seem impossible,

    The least of evils seems the best, thus choice rests with what is acceptable.

    For now, the agreement OPEC struck on Wednesday looks acceptable, if not necessarily perpetual.

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