Although countries saying they’ll freeze oil production account for 25% of global supply, conditions of their Feb. 16 agreement and history offer little reason to expect much change in an oversupplied market.
Of four countries agreeing not to raise production beyond January levels—Saudi Arabia, Russia, Qatar, and Venezuela—only one has enough spare capacity to do so meaningfully.
Saudi Arabia produced at an average rate of 10.19 million b/d in January, according to the International Energy Agency. That was up slightly from December but still 2.05 million b/d less than IEA’s estimate of the kingdom’s production capacity.
The other two members of the Organization of Petroleum Exporting Countries in the agreement produced at or near capacity rates in January: Venezuela at 2.37 million b/d and Qatar at 680,000 b/d.
Russian production rose to 11.22 million b/d after averaging 11.09 million b/d in 2015, according to IEA.
But Russia’s recent production climb reflects start-ups of several fields by companies benefiting from ruble devaluation against the dollar and a tax structure subject to change. Internal conflicts raise questions whether the country’s production gains can continue.
Questions about Russia
In a study published earlier this month by the Oxford Institute for Energy Studies, Senior Research Fellow James Henderson and Bassam Fattouh noted that Russian companies have strong motivation to maintain oil exports.
They not only benefit more than major producers elsewhere do from currency devaluation, the analysts said, but also enjoy “significant protection” from the Russian tax system.
Because of a high marginal tax rate when the crude price rises above $25/bbl, “the government has taken most of the cost of the falling oil price.”
The disparity gives the government stronger incentive than Russian companies have to limit production in defense of the crude price.
And the government has fiscal problems. Its 2016 budget projects a deficit of 3% of gross domestic product assuming an oil price of $50/bbl. An oil price of $30/bbl would raise the deficit to 4.5% of GDP and might exhaust the country’s reserve fund by yearend, according to Henderson and Fattouh.
With the new deal less ambitious than a production decline and thus less supportive of crude prices, the government might feel new pressure to raise taxation of producers to boost immediate receipts. Henderson and Fattouh were responding to January rumors about a coordinated production decline and didn’t address that possibility, which would discourage oil field investment and limit whatever scope remains for further production hikes.
Even if Russia could raise production much beyond current rates, the question remains whether it would exercise the restraint required by the new deal. History suggests it would not.
Henderson and Fattouh pointed out that past attempts by Russia and OPEC members to coordinate production cuts—in market slumps of 1997-98, 2001-02, and 2008-09—have stumbled on Russian noncompliance.
“Russia has a strong record of both encouraging OPEC to make cuts at times of low oil prices while also promising, but not delivering, reductions in exports itself,” they wrote.
The conditions
Conditions of the Feb. 16 deal are general: The four parties agreeing to freeze production expect other producers to do the same.
But what producers?
The oil-price slump already suppresses output from most of the big gainers of recent years, such as the US, where production is falling; Canada, where output is flattening and oil sands investment is plummeting; and Brazil, where a political crisis aggravates oil-market stresses.
Iraqi production continues to rise steadily, having reached 4.35 million b/d in January. But economically strained Iraq has been excluded from OPEC production management for years and isn’t likely to feel obliged to adhere to a new agreement.
Iran, meanwhile, began raising production late last year in preparation for cessation of international sanctions, which occurred last month. Iranian output reached 2.99 million b/d in January, its highest level since June 2012, as the government insisted it would bring 500,000 b/d of new supply promptly to market and a like amount with 6 months.
Whether Iran can achieve those production ambitious remains in question. But its government so far has shown no interest in international agreements to limit oil supply.
Whether the conditional four-party deal can do much to balance the oil market thus remains in question. More certain is its ability to highlight fractures within OPEC and between the organization and other oil exporters.
Contact Bob Tippee at [email protected].
