The agreement to freeze oil production will do little to rebalance the market.
Russia, Saudi Arabia,
Qatar and Venezuela agreed on 16 February to freeze
oil production at January levels, if other countries join in. Despite the
publicity, the move does not change the dynamics of the oil market in any significant
way. Its impact is likely to be limited for three reasons:
1. The quartet
alone have limited potential to increase production anyway. Annual oil production
in Qatar and Venezuela is expected to decline in 2016, according to forecasts
from Goldman Sachs. And while output in Russia and Saudi Arabia is expected to
rise this year, some of this might have already been realised in January. Total
production from the quartet is expected to increase by only 270 thousand
barrels per day (k b/d), not enough to rebalance the market in a meaningful
way.
2. The main growth
countries (Iran and Iraq) are unlikely to join the freeze. Iran can convincingly
argue that it needs to make up for the lost production during the years of
economic sanctions. It currently produces around 0.7m b/d below its 2012 peak.
Meanwhile, Iraq is struggling with revenue shortages and a large budget deficit
and is unlikely to commit to any cap to its oil production. Indeed, the
statement issued after oil ministers from the two countries met with their
Qatari and Venezuelan counterparts was polite
but lacked any enthusiasm to join the deal.
3. The output freeze
is unlikely to be a precursor to a future production cut agreement. OPEC’s strategy
to increase production, defend market share and squeeze US shale oil firms out
of the market is finally bearing fruit. US oil production is expected to
decline by 492k b/d this year as US oil firms are unable to recover their costs
under current oil prices. A production cut from OPEC could give these firms a
lifeline to come back into the market and fill the gap vacated by OPEC.
In addition, OPEC
will probably face internal disagreements on how to allocate any production cut
among member countries. Even if these disagreements were resolved, temptations would
be high for individual countries to deviate and produce more.
So despite initial
market enthusiasm, the production freeze agreement is unlikely to be a game
changer.
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