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OPEC Reaches Deal on Production Freeze

History On The Deal

So finally, we get to give some good news!!!! We have a deal from OPEC on a production freeze. As you might remember, OPEC reached a preliminary deal in September to reduce their collective output to 32.5 million to 33 million barrels per day (compared to 33.6 million barrels the cartel pumped in October). The deal was, as I said in a prior Five Star Standard, an agreement to agree and very short on specifics. Certain countries appeared to be exempted, Iraq was pushing for more production, and the production cuts where not allocated amongst member countries.

As we got further developments, we continued to update you. Iraq wanted to produce more, as did Iran, and Saudi Arabia pushed back. As late as last week, the politics continued as the technical people met ahead of the actual negotiators to try and work out some details, and Saudi Arabia appeared to be backing out by saying that oil markets would rebalance next year regardless of any OPEC action so cuts were unnecessary. Cleary, this was all gamesmanship as each country attempted to establish what, when I was a lawyer negotiating cases we called “the baseline.”

Each member sought to control the narrative and the dialogue. Poor Iraq – hammered by years of war, engaged in a global fight against ISIS terrorists, having its production reduced through acts of war at a time when it desperately needs money to fight ISIS – how could we possibly ask them to reduce their output? Again – it was all about controlling the narrative so that you can establish what is reasonable.

Take a classic lawyer example. If I have 5 apples, and you have ten oranges, and I want to trade you my apples for your oranges, you might say “No, I have 10 pieces of fruit and you have only five. That’s not a fair trade.” To which I might counter – “But an apple a day keeps the doctor away. Everyone knows that an apple is better than an orange – they don’t say an orange a day keeps the doctor away. So because my fruit has more nutritional value, you have to trade me more of yours to be equal to what I’m giving up.” This gamesmanship is the chatter we have seen over the past several months.

Either way, markets have been going up and down during the past few months depending on traders’ moods about whether a deal would come to fruition. On November 30, 2016, OPEC agreed to its first output cuts since 2008 (a year Saudi Arabia basically went it alone – cutting its own production – so does that really count?).

What Deal Did We Get?

First, OPEC (which remember, produces about a third of the world’s oil) agreed to reduce production by around 1.2 million barrels per day beginning January 2017.

The good news for our industry is that Saudi Arabia (who, up until now, has still been drilling new wells) will take the vast majority of the production cut. Saudi Arabia will bear a 500,000 barrel per day reduction (thereby reducing production to about 10.06 million barrels per day). Saudi’s good friends – the UAE, Kuwait, and Qatar (who are not so incidentally, the U.S.’s friends in the region) agreed to cut output by 300,000 barrels per day. Shockingly, despite their earlier objection, Iraq will take a 0.2 million bpd hit.

Iran has agreed to freeze production at close to current levels, rather than cut, which is a major diplomatic victory for the Islamic Republic.

Below is a summary by country created by John Kemp of Reuters:

 opec output nov16

I would note that to reach agreement, OPEC had to get a bit creative on what the “baseline” was. For example, if you look at Iran above, their current production is only 3.690 mmbpd, but their baseline is 3.975, which is the high they obtained in 2005. So, under the current deal, their cut allows them to increase production by 90,000 bpd. The math gets tricky.

Other Country Participation

OPEC called on non-member countries to participate. As you may remember, we got some mixed signals out of Russia on their willingness to participate and make production cuts, but overall, they did seem to favor some action and seemed willing to cooperate on some level. On November 24, 2016, Bloomberg reported that Russia had signaled their willingness to freeze their production at current levels (which would mean Russia would produce 200,000 to 300,0000 barrels per day in 2017 less than their plan). Apparently, OPEC had asked non-members to contribute 500,000 barrels per day. (Read more: https://www.bloomberg.com/news/articles/2016-11-24/russia-tries-to-dress-up-oil-freeze-as-cut-amid-opec-pressure).

However, Russia later softened its position. Apparently, non-OPEC producers have agreed to reduce their output by 0.6 million bpd, of which Russia will cut 0.3 million bpd during the first half of 2017.

 Other countries have indicated that they might also cut (Azerbaijan and Kazakhstan), but there is no firm commitment yet.

The Rest of the Story

As we noted earlier, a bunch of politicking went on prior to the deal. Iraq argued it should have more clout than Iran as it is now OPEC’s second biggest producer. Iran argued it should get more preference than Iraq as it just got released from all those “repressive” sanctions. Saudi Arabia doesn’t want to help Iran but needs Iran to agree. And then you have a partridge and a pear tree: Saudi Arabia announces that no freeze is necessary days before the meeting as they declare that oil markets will rebalance themselves without OPEC intervention in 2017 anyway – but a deal is still good as it hastens the process.

Interesting, on December 1, 2016, Reuters gave us some of the back scope on the story. Click here to read more (http://www.reuters.com/article/us-opec-meeting-idUSKBN13Q4WG). According to sources close to the negotiations, Russian President Vladimir Putin played a critical role in helping Iran and Saudi Arabis set aside their differences. Allegedly, Putin, Saudi Deputy Crown Prince Mohammed bin Salman, and Iran’s supreme Leader and President Rouhani worked together with Putin acting as in intermediary between the Saudis and Iran.

Allegedly, it started in September when Putin met Prince Mohammed in September on the sidelines of a G20 gathering in China and the two agreed to cooperate to help clear the glut.

Days before the deal, when things appeared to be falling apart, Putin established that the Saudis would shoulder the lion's share of cuts, as long as Riyadh wasn't seen to be making too large a concession to Iran. A deal was possible if Iran didn't celebrate victory over the Saudis.

A phone call between Putin and Iranian President Rouhani smoothed the way. After the call, Rouhani and oil minister Bijan Zanganeh went to their supreme leader for approval, a source close to the Ayatollah said.

In effect, Putin gave both sides a win – Iran got to claim it wasn’t bending to political pressure, and the Saudis got the agreements they needed. With Iran and Russia simply freezing production, Saudi Arabia could argue that the Kingdom’s cuts didn’t simply allow others to obtain market share at their expense.

What Does It Really Mean?

At the end of the day, if everyone complies, we have a combined output reduction of 1.8 million bpd. This represents about two percent of total output. In my opinion, this will be sufficient to not only send the market into balance, but also to allow stockpiles to be reduced. The IEA, assuming the cuts happen, believes we will move from surplus to deficit very quickly in 2017, leading prices to rise sharply once the existing stock overhang is substantially reduced.

One major problem is Indonesia. Indonesia is no longer a net exporter of oil, and thus has had its OPEC membership suspended. This means that OPEC merely stopped counting 750,000 barrels per day.

All of this probably is not sufficient for us to see $100.00 a barrel oil anytime soon. Probably not even $75.00. but what we have seen from prior articles, is that shale companies have gotten their houses in order and the cost of production in the U.S. has drastically decreased. This gives oil companies, particularly independents, and more importantly, their lenders, some confidence that they can proceed. How quickly will they ramp back up production? Who knows.

By: Ty Chapman

Five Star Metals, Inc.

Raising the Bar for Customer Service and Quality

Twitter: @FSM_TY

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