Mar­ket sig­nif­i­cance of the Doha meet­ing

Financial Mirror (Cyprus) - - FRONT PAGE -

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.

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