OPEC Flirts With Production Freeze

Oil rallied this week based on talks of a possible production freeze by OPEC. . Saudi Energy Minister Khalid Al-Falih stated “We are, in Saudi Arabia, watching the market closely, and if there is a need to take any action to help the market rebalance, then we would, of course, in cooperation with OPEC and major non-OPEC exporters”. OPEC will meet informally in Algeria in September.

Russia later confirmed that they are willing to consider a production freeze as well.   While markets reacted positively, one must remember that this is not the first time OPEC and non-OPEC exporters have meet to consider a production freeze. In fact, previous efforts to freeze production occurred at OPEC meetings in November 2014, June 2015, December 2015, and June 2016, all ended in failure. Moreover, OPEC has every incentive to act as though a production freeze could happen simply to drive up the price of oil with words alone.

So, what makes a deal more likely? First, growing economic and financial strain is not only hurting smaller and less important OPEC members (like Venezuela that needs $100.00 per barrel oil to balance its budget), but wealthier countries as well like Saudi Arabia, Russian, and Iran, that are struggling under low price oil. Iran’s oil output is now closer to pre-sanction levels, so they may be willing to agree to a freeze at this level (which is substantially higher than the Doha meeting when a freeze was last attempted and resulted in a very quick failure).

But many problems remain. OPEC certainly has to fear that increasing prices would revive the U.S. shale industry and cause struggling producers to start drilling again, thereby threatening OPEC market share. Saudi Arabia is unlikely to agree to any freeze unless all OPEC and Russia agree to a freeze, which Iran may be unwilling to do (See our article last week on the new Iranian Oil Contracts). In addition, OPEC has always had concerns about other members cheating, which have historical precedent. Additionally, as supply and demand continue to converge, OPEC may take a wait and see approach.

For a more full analysis of what makes a deal more or less likely, click here.

Ty’s Take. Personally I give a very low probability to any production freeze at this time. With supply and demand expected to converge later this year, a natural recovery is becoming more and more imminent. The best cure for low oil prices is low oil prices. This spurs demand – some of which will be here to stay when oil prices recover and some of which will have been a temporary response. But I do not expect to see OPEC suddenly give a breath of life to struggling U.S. shale producers. That will happen in due course. Furthermore, even if they agree to a production freeze, the benefit will not be that substantial as OPEC is pumping at record high levels.

Ty Chapman

Five Star Metals, Inc.

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Ty’s Take for Week Ending August 19, 2016
The Week In Numbers for the Week Ending 8-12-2016

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