The year 2016 for the Saudis will be memorable for all the wrong reasons: war, regional insecurity and a fiscal crisis. Saudi King Salman bin Abdul-Aziz Al Saud's second year witnessed serious financial difficulties for the kingdom for the first time in decades, a war with neighbouring Yemen that isn’t likely to fade away and continuing low oil prices.
With the war-machine consuming money at an alarming rate, rising unemployment at home and other negative economic indicators pulling the kingdom down, the house of Saud had to act. After resisting oil production cuts for years, the sheikhs in Riyadh rustled up support to finally press for global oil output cuts.
Consensus at Vienna
At a meeting in Vienna on 30 November 2016, OPEC members met and agreed to cut oil production. It wasn’t an easy decision as most OPEC oil producers experiencing years of low prices since 2014 have been severely impacted by falling revenues and yawning budgetary deficits.
Not unsurprisingly, the decision came after months of negotiations with not just OPEC members but other major oil producers, including Russia which is the world’s largest oil producer. A total of 11 oil producing nations agreed to cuts.
The final agreement required the major oil producing states to cut production by about 1.2 million barrels per day (mbpd) from January 2017 onwards. Several nonOPEC producers have agreed to contribute to lower production to the tune of 0.6 mbpd.
The three countries that agreed to major cuts are Saudi Arabia, the UAE and Kuwait. Together they agreed to take on two-thirds of the cuts while the rest are spread among seven other producers.
Iran is the one country that has been exempted from cuts chiefly because its production has been mostly below 4 mbpd from the time Western sanctions were imposed in 2011. This is an Iranian victory because the Saudis had been insisting that Iran contributes to the cuts. In the end, continued Iranian defiance paid off as Riyadh searching for a consensus was forced to accede to Tehran’s argument that it was already suffering due to Western policies.
Libya and Nigeria, the two other major world oil producers, were also exempt from the cuts primarily because they cited severe economic disruptions due to various factors beyond policy control. These two countries are free to actually expand production.
Expected Impact
The jury is still out on what impact the production cuts pact will have on oil prices. Oil producers are optimistic and claim that prices will climb back to pre-2014 levels. But many analysts argue that peak prices are unlikely due to several factors.
Firstly, analysts argue that a 1.2 mbpd cut in overall oil production by the major producers is not a significant figure given that world oil production currently stands at somewhere above 97 mbpd (end-2015) estimate, perhaps even at 100 mbpd by some calculations as precise figures are not available.
Therefore, the cuts work out to about a 1.2 per cent cut. This is far from huge especially given the fact that production levels are up from 2014 when prices were at its peak.
Just how modest the cuts are can be judged from the fact that Saudi Arabia’s production levels as per the 30 November accord are set at 10.1 mbpd as against its current estimated production of 10.5 mbpd. However, even this is 800,000 barrels more than the country’s production level in 2014 (9.7 mbpd).
This is roughly the case with the other producers, most of whom have raised production in the last couple of years. This means that production levels are unlikely to fall to pre-2014 levels.
The biggest challenge to the November pact will come from the United States which has been steadily ramping up production of shale oil and thus contributing to a gradual but significant long-term rise in global oil output. Some experts opine that US shale oil production could go up by as much as 500,000 bpd during 2017.
Brazil and Canada too are increasing production capacity at a faster rate than the US and together the three countries will add substantially to the total available oil in 2017.
Moreover, China, one of the world’s biggest oil consumers, is facing a continued slowdown and decreased oil consumption. At the same time, it is planning to push up domestic crude oil production to 200 million tonnes by the year 2020.
Overall demand for oil too is expected to ease with the International Energy Agency (IEA) estimating that global demand increase will decline to 1.3 mbpd in 2017 from 1.5 mbpd last year.
OPEC Power
The larger geo-economic question is whether OPEC and Saudi Arabia in particular, will continue to hold the key to set global oil prices?
The answer, in short, is no.
The very fact that the Saudis had to enlist the support of non-OPEC countries, particularly Russia, for its production cut decision proved that OPEC is no longer the all-powerful cartel it once was. Therefore, it is unlikely that the latest accord will transform global energy equations.
The Iranian victory over Saudi intransigence was another indicator that the Arab sheikhs no longer have a controlling influence over oil producers, even in the region.
This leads to a problem of compliance. Everybody at Vienna pledged cuts but will they stick to the set targets, especially if prices don’t rise as anticipated? This remains an open question and could effectively nullify the effects of the output cut decision.
December 2016 output was down by more than half a million bpd mainly because of cuts by Saudi Arabia, Kuwait and UAE. Inventories too were drawn down. Prices rose but volatility in prices might not signal a substantial continuous rise.
The cartel members are trying to ensure that the pact holds and their members are assembling in Vienna once again to monitor compliance.
Efforts to enforce solidarity amongst oil producers could well be an exercise in futility as the world, particularly the West, fast moves away from conventional energy sources.
Intractable differences between key producers especially the sheikhs of Arabia and the mullahs in Iran. As well as the dire need for revenues could also mean the end of the geopolitical power of the oil cartel.