Sunday, 21 February 2016

The oil production freeze is no game changer

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.

No comments:

Post a Comment