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OPEC production freeze struggles to find output cuts
October 8, 2016, 3:47 pm
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In late September, OPEC members pulled off a rare show of unity at their meeting in Algeria by agreeing to cut production. The output cut envisions going from the current 33.5 million barrels per day (BPD) to between 32.5 and 33 million bpd and to establish a committee to recommend production levels for members in consultation with non-OPEC producers. The organization expects to finalize this agreement at its next policy meeting in November and thereby goad prices to a new high.

However, the notion of OPEC finding a new high is fraught with uncertainties. While the OPEC meeting in Algiers agreed to a production cut, what is actually being contemplated is a production freeze. These are two fundamentally different policies which when examined more closely reveal the infighting among OPEC’s largest producers.

In August, OPEC was producing 33.25 million bpd, implying it would have to cut 250,000 to 750,000 bpd to fall within the newly designated range. Analysts note that Saudi Arabia and many OPEC members pump more oil during the summer months to meet increased domestic demand for power generation.

For instance, Saudi Arabia has consistently increased summer production by 400,000 bpd. With just the Saudi production coming offline in the fall, OPEC would achieve its designated output cut. So, basically what other OPEC members are being asked to do by the agreement reached in Algiers is to undertake a production freeze rather than any production cut.

The truth is that while OPEC has carrots, it simply lacks the sticks to enforce members to toe its line. Since mid-2014, when oil prices began to fall and Saudi Arabia and its allies in the Gulf Cooperation Council (GCC) countries maintained a ‘lower for longer’ policy, most other OPEC member states have filled their revenue gap by pumping more oil — a double-edged sword which solved one problem and exacerbated another.

Following the lifting of international sanctions against it, an emboldened Iran has been ramped up its oil production, clawing back market share faster than many expected — from 2.75 million bpd to over 3.6 million bpd. A target of 4 million bpd is now within reach.

Nigeria, Libya and Iraq, which have all faced cuts in their output due to political volatility, are also unlikely to agree to any reduction in production, at least until they regain their previous output levels.

Even if OPEC can overcome these issues and corral its members to agree and enforce a production cut, nothing stops the US and other non-OPEC members from boosting their production to fill the production void. The US shale industry in particular has proven to be much more resilient than many had given it credit for.

OPEC may believe that a production freeze could boost oil price enough to have a meaningful impact, but with such a thin margin between market equilibrium and oversupply, any OPEC or non-OPEC member’s production bounce-back will easily scuttle the plan.

Meanwhile, though international oil markets took news of OPEC’s intended production cut positively and prices have risen to around US$50 per barrel, it has had a largely negative impact on regional markets. Saudi Arabia saw its market going down by 5.5 percent for the week and 7.5 percent for the month. During the same week, Dubai went down by 1.11 percent and Abu Dhabi by 0.86 percent, while both Egypt and Kuwait both were down by 0.41 and 0.14 percent respectively. Bahrain and Qatar were the only two markets ending the week as gainers going up by 1.4 and 0.2 percent respectively.

The decision taken by the Saudi Government to reduce ministers’ salaries by 20 percent and cancel bonus payments for state employees alongside US congress approving a law that effectively allows citizens to sue Saudi Arabia for 9/11 combined to offset the OPEC news and provide a major catalyst to the severity of the downward move.

According to a market analysts, any attempts to close the year on a positive will depend on oil price finding a new high, but this could prove challenging in front of declining regional prospects and a spooked global environment going into the US November general elections.

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