Market significance of the Doha meeting
Crude oil has been plagued by extreme levels of volatility this year. Crude oil prices have endured a roller coaster ride since 2015, reaching a nadir in Q1 2016. Such was the precarious predicament of the world’s most highly watched commodity that oil ministers from OPEC and non-OPEC countries decided that the time is nigh to schedule an urgent meeting in Doha, Qatar on Sunday, April 17. What is significant about this meeting is that it focused on reducing overall oil production to January levels in an attempt to stabilise oil prices. Since it involves OPEC and non-OPEC nations in Saudi Arabia and Russia as the chief signatories, it has been one of the most highly anticipated meetings for the industry in decades. In February, when news of the meeting broke, oil prices rallied by as much as 35%. But the real test of the meeting’s success will hinge upon the aftermath. It is already public knowledge that Iran and Saudi Arabia will not agree to production cuts if other major oil producers refuse to cut output accordingly. The meeting in Doha was attended by 15 major oil-producing countries from the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC countries. Once again, the issue at stake is a production freeze.
The reason why the Doha meeting came to pass was an oversupply of crude oil as major OPEC and non-OPEC countries were desperate to maintain market share at the expense of all else. OPEC countries simply refused to reduce output for fear of losing their slice of the pie, since nonOPEC producers, in the form of shale oil producers and Russia, were coming on in leaps and bounds. Now, OPEC has additional problems to contend with, with the readmission of Iran into the global oil arena. The punitive sanctions forced upon Iran over its disputed nuclear programme have since been removed and Iran is intent on pumping out as much crude oil as possible to make up for lost time. What this means for other OPEC producers, non-OPEC producers and the rest of the world is that the glut of crude oil far exceeds the present demand.
The urgency of the Doha meeting gained momentum with the readmission of Iran into the fold. Talk of production cuts in crude oil first gained momentum in February when both Saudi Arabia and Russia tentatively agreed to cut production to January levels in an attempt to shore up the price of crude. By reducing outputs, the oil supply curve effectively shifts to the left, causing the price to rise at reduced supply. The main signatories to the Doha talks include Venezuela, Saudi Arabia, Qatar and Russia. According to the terms of the Doha talks, production levels would be frozen at January quotas for a period of ten months in order to stabilise oil prices to allow producers to recover some of the losses that they have been enduring and to bring about market equilibrium between supply and demand. Such was the pressure facing Brent suppliers that the price per barrel plunged below $28 soon after the new year began.
The downturn in crude oil prices began midway in 2014. In order to understand how badly major oil-producing countries are being impacted by weakness in oil prices, one has to look at an economic variable known as the breakeven price. For Nigeria, the breakeven price is $122.70 a barrel, for Venezuela it is $117.50, for Algeria $114.80, for Iraq $77 and for Libya $68.80. Based upon current prices in the $40-$45 range, it is clear that these countries are losing money hand over fist. The urgency to come to consensus about capping crude output at January levels could not be any greater for these oil-producing nations. In fact, the declines in their overall revenues have been so harsh that GDP has shrunk precipitously as a result of declining oil price revenues. As a case in point, the Saudi economy has endured a 9.4% increase in its annual debts as a percentage of GDP. This is due in no small part to the high reliance on social welfare in the kingdom, which has heretofore been funded by oil revenues.
In much the same fashion, the Venezuelan economy shrank by 5% last year as crude prices plunged by as much as 40%. For their part, the Saudis have embarked on stringent austerity measures by reducing social welfare spending, increasing taxation and selling off vast quantities of forex reserves. In fact, such is the dire predicament of the economies of Nigeria, Venezuela, Algeria, Iraq and Libya, that many analysts believe there is simply no hope for their recovery since the oil price crash began in June 2014. By capping crude prices among OPEC and non-OPEC signatories like Russia, it is possible that inventory buildup will slow and eventually deplete, and prices will begin to rise. Presently, OPEC has maintained a production cap of 31.5 mln barrels of oil per day, but it routinely exceeds that amount by almost 1 mln bpd.
Currently, the price of WTI crude oil on Nymex is $40.36 a barrel (as at 15 April), and the price of Brent crude is $43.10 a barrel on the London Ice Exchange. But the efficacy of any such arrangement between Saudi Arabia as the powerbroker of OPEC and Russia as the leading non-OPEC country remains in doubt. The reason for this is Iran. This country has been shut out of the oil markets for several years and its economy has been ruined in the interim. Now, Iran refuses to comply with any calls for production cuts that may be better for the overall oil industry, since it feels entitled to produce as much as it wants given the current state of its economy. Progress is naturally being impeded by the constant butting of heads between the Iranian and the Saudi oil ministers. Discussions of a possible oil freeze do not sit well with the Iranians, much to the dismay of the Saudis. Further afield, across the Atlantic, shale oil producers in the US have been feeling the pinch with weak oil prices. Already, the Baker Hughes reports have shown a consistent decline in the number of active US oil rigs.
US producers believe that if they stay on the sidelines and allow Russia and Saudi Arabia to agree to production cuts, it will naturally be to the benefit of shale oil. It is entirely possible that the number of US oil rigs currently operating will increase, and higher oil prices will bring many more rigs back online.
In terms of global production, OPEC controls 33% of global oil supply and Russia is the second largest producer of crude oil. The problem is that these countries are already at maximum supply and they cannot impact much on the global oil markets, with the exception of Iran which wishes to produce up to 4 mln bpd. According to the International Energy Agency (IEA), oil demand is likely to increase by 1.2 mln bpd in 2016, and if that is factored in with an oil production cut at Doha, prices will invariably rise as inventory levels will be depleted. Presently, global production of oil is 96.4 mln bpd. This exceeds demand by 1.6 mln bpd (Q1 2016). If the IEA’s reports are to be believed then provided things remain the same, demand and supply will have only a 0.5 mln bpd shortfall between them. This will mean that inventory levels will be increasing at a decreasing rate and prices will invariably rise.