The Oil Game Heats Up As The Freeze Melts Down

In Doha this weekend, the world's largest oil producers met to discuss the possibility of an output freeze in hopes of supporting the depressed price of oil. Saudi Arabia and other OPEC nations invited its competitors to the negotiating table looking to bolster their energy income. Approximately 20 countries took their seats around the table representing over 50 million b/d of production, that's over half the 80 million b/d average that was produced in 2015. Here's a list of those participants from MarketWatch.

The goal of the meeting was to “agree on a collective OPEC and non-OPEC oil output freeze to January 2016 levels, in an effort to halt the nearly two-year oil price collapse,” said Economou. Members of OPEC such as Venezuela and Nigeria had already called on their own constituents to support the price of oil as their economies fell into a downturn. An interim freeze with Saudi Arabia, Kuwait, and the United Arab Emirates garnered hope for a broad freeze that could incorporate even non-OPEC producers like Russia. With producers from the U.S., Russia, and the oil cartel pumping oil at all-time highs, investors saw a bullish move as unlikely.

In the Monthly Oil Market Report put out by OPEC, the reported production data reveals an interesting trend in the output of its members. Members like Algeria, Angola, Ecuador, Kuwait, Libya, Nigeria. Qatar, the U.A.E., and Venezuela have had only small increases or decreases in daily production from 2014 to last year. In fact, the total difference in production for these countries is a loss of 82,000 b/d as price tumbled over 50%. As price fell sharply, it was expected that, on average, output would fall as demand for extra oil was absent. With a price stabilization in 2016, most investors think that production will jump back up. Estimates for the six OPEC members listed above have a net gain of 380,000 b/d for 2016. That's compared to estimates for Iraq, Iran, or Saudi Arabia which are increases of 421,000 b/d, 763,000 b/d, and 2,202,000 b/d.

These smaller players have shown their vehemence in supporting an output freeze or even a quota. Their inability to simply pump more oil or tap into stored away reserves leaves their revenue vulnerable to the whims of prices on the market. With just a fraction of the total market share, they are forced to side with a larger producer when deals are being made in an increasingly competitive environment. In that way, extra capacity seems to be the strongest weapon in this war. That's exactly why U.S. shale producers seemed so powerful, their growing capacity was voracious and quickly getting cheaper.

While these non-OPEC producers did not show up to the meeting, the leading producer of crude oil was finally recognized as an honorary participant. Bringing in Russia was a must for Saudi Arabia if they wanted to secure control over the crude oil landscape as the Eurasian giant control over 1/8th of total world output. Or was it? Russia's crude might seem influential on price as they have the largest individual output, but in reality, they haven't expressed their power as a swing producer. Most of the bearish pressure has come from the United States and Saudi Arabia ramping up extraction rates in a power struggle. Russia, on the other hand, has only increased their total output by 199,000 b/d since 2013, so entering into a freeze deal would be almost pointless. Negotiating a coordinated cut with them would prove to be even more futile given the disparaging economic situation in which the country finds itself. Russia's quarterly GDP growth rate has been negative since July of 2014 and won't return positive until energy prices improve as natural gas and crude oil account for 68% of the country's revenue.

So if Russia doesn't matter, U.S. producers weren't invited, and the smaller players have no power, why did Saudi Arabia's al-Naimi demand a meeting in Doha this weekend. The answer once again lies in new, sanctionless Iran. The country that has just agreed to abandon any plans of developing nuclear weapon now boasts the most viable production capacity in the industry. While under the sanctions, output was held close to 3 million b/d, but Tehran's oil minister has declared the desire to pump upwards of 4 million b/d. Forecasts from the IEA have Iraq bringing 763,000 b/d of production back online to bring the total change from 2014 to 834,000 b/d. The only other country who can bring that capacity to the table is Saudi Arabia and maybe Iraq, which is projected to bring 421,000 b/d by the end of 2016. It's clear that the rivalry is getting more intense.

Going into the meeting, Saudi deputy crown prince Mohammed bin Salman reminded everyone that a freeze could only happen with Iran. To the chagrin of constituents who hoped to reach an agreement (like those smaller players mentioned earlier) the crown prince and oil minister al-Naimi continued to insist in Iranian's involvement despite their absence in Doha. If Tehran does not get on board and a freeze does happen, a sizable increase from the Persian nation can render any output changes (or lack of changes) useless. Speculation over the freeze should have been muted until Iran showed interest in cooperating with other member countries. Perhaps that's why we saw so much uncertainty in spot price trading before the meeting in Doha.

From WSJ
It's not just the extra capacity that makes Iran a threat to Saudi Arabia's recent market share way but also the similarities in operations. Both nations produce the same kind of oil, typically darker, sour crude that's traded under the OPEC basket prices. According to the Wall Street Journal, Saudi Arabia produces crude oil at $8.98 a barrel with $3.00 worth of production costs, and Iran produces crude oil at $9.08 with only $1.94 worth of production costs. These nations can add barrels of oil to the market more efficiently than any other of their industry peers. U.S. shale producers have to pay almost two and half times to produce that same barrel. The tension between the two OPEC members could get even more divisive when Asian demand starts to increase again, and they'll have to battle for every inch of market share in the region. By then, we could have seen the end of the oil cartel for good.

Should we be surprised that Doha didn't end in a deal? Not really. The polarization of Iran and Saudi Arabia was and always will be too strong to reach an agreement in the short-term. Investors seemed to acknowledge the irreversible futility in today's trading. The WTI spot price fell to $38.00 a barrel at the start of the trading session and slowly climbed to close at $39.89 a barrel. The late rebound gives hope that this week could be bullish despite the overwhelmingly bad news that some oil investors would label the failed freeze. In the long run, those two countries will have control over the market as they have the most capacity that can be efficiently added. It's time to look past Doha and on to the next production trend going into the second quarter of 2016.



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