OPEC Meeting: Potential Outcomes

The future of the oil price — and the economic stability of key African countries — hang in the balance this week, as the Organization of the Petroleum Exporting Countries (OPEC) meets tomorrow to hash out a potential new deal on oil production cuts.

Questions on the likelihood of a new deal swirl as the world’s top oil men head to Vienna. How is pressure from U.S. President Donald Trump influencing Saudi Arabia, especially in light of the killing of Saudi journalist Jamal Ahmad Khashoggi in October? How will the remarkable recovery of U.S. shale affect the conversations in Vienna? Will Russia again decide to join traditional rivals on production cuts? What does Qatar’s decision to withdraw from OPEC have to do with the deal?

The decisions made on Thursday will have serious ramifications for Africa’s oil producers.
Indeed, oil producing countries like Equatorial Guinea, Nigeria and Angola are especially vulnerable to the possibility of low oil prices. Equatorial Guinea, for example, went from a GDP growth rate of 8.3 percent in 2012 to GDP contractions in 2015, 2016 and 2017 after the oil price crashed, with the economy contracting by 2.5 percent in 2017.

Angola’s budget deficit reached 5.3 percent of GDP in 2017 and inflation reached 26.3 percent.
Nigeria, Africa’s largest oil producer and its second largest economy, suffered through its first recession in two decades because of the drop in oil prices.

“Just two years ago, the oil and gas industry was in turmoil and new investments in the industry were put on hold or cancelled altogether,” said H.E. Gabriel Mbaga Obiang Lima, minister of mines and hydrocarbons of Equatorial Guinea, in a press release. “But the markets have experienced a remarkable recovery due in large part to the commitment of all OPEC and Non-OPEC countries in the historic Declaration of Cooperation.”

The Declaration of Cooperation, which removed 1.8 million barrels of oil per day from the market, was signed in December of 2016, implemented in 2017 and was later extended several times through 2018. Now, OPEC and key non-OPEC countries that are crucial to success of the production cuts, especially Russia, will decide yet again on a deal.

Oil Price Teetering

November saw the biggest one-month decline in oil prices since the crash of 2014, which sent several oil-dependent economies across the world into recession.

In the last two months, oil has declined by about 30 percent. Today, Brent crude is trading at $61.36 a barrel and WTI is trading at $52.58 per barrel.

Oil was initially up on Tuesday, after new reports that Russia was keen to continue some level of production cuts, but dropped again Tuesday afternoon, as the American Petroleum Institute reported an increase of crude oil inventory of 5.8 million barrels for the week ending November 30. The buildup came as a surprise, with analysts originally predicting the report would show a drawdown of oil inventories of 2.267 million barrels.

The Questions

How is pressure from U.S. President Donald Trump influencing Saudi Arabia, especially in light of the killing of Saudi journalist Jamal Ahmad Khashoggi in October?

The pressure from Trump could be the biggest unknown heading into Thursday’s meeting, with Saudi Arabia unusually vulnerable to demands from its ally in the West after Saudi journalist Jamal Ahmad Khashoggi was killed in a Saudi consulate in Turkey in October. While the international community has condemned Saudi Arabia’s Crown Prince Mohammed bin Salman for the killing, Trump has taken a softer approach, saying: “We may never know all of the facts surrounding Khashoggi’s death,” and that “our relationship is with the Kingdom of Saudi Arabia.”

At the same that Trump has offered his unilateral support for Saudi Arabia, however, he has also come down hard on OPEC and Saudi Arabia for production cuts and high oil prices. Less than a day after Trump made his support for the Crown Prince public, he tweeted: “Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!”

“The priority for Saudi Arabia is shoring up Mohammed bin Salman (MBS’s) position, and the key part of that is securing Trump’s backing,” Derek Brower, a director of RS Energy Group, told the Financial Times. “Trump has clearly linked his support for MBS with several things … but it’s oil that seems to be at the top of his agenda.”

How will the remarkable recovery of U.S. shale affect the conversations in Vienna?
The US shale industry, which largely crashed with the oil prices in 2014, made a rapid comeback beginning in 2016 as oil prices began to rise. No doubt, U.S. producers capitalized on the OPEC-led production cuts, and the subsequent increase in the oil price, to raise production. And, for the first time since the 1970s, the U.S. regained its spot as the top crude producer in the world earlier this year after ramping up production while Saudi Arabia and Russia — the traditional No. 1 and No. 2 producers — capped production in line with the cuts.

The increased production by the U.S., as well as the shift in its role from an oil importer to an oil exporter, has certainly limited OPEC’s complete control of the oil market. Indeed, the original Declaration of Cooperation would not have been possible without several non-OPEC members (10 today) that also signed onto the production cuts.

And as inventories continue to rise as U.S. oil output increases — including the report by the American Petroleum Institute on Tuesday on the buildup of oil inventory of 5.8 million barrels for the week ending November 30 — there is concern that OPEC’s dominance of the market is dwindling.

Will Russia again decide to join traditional rivals on production cuts?
As OPEC loses its firm grip on the oil markets, the cooperation of top non-OPEC oil producers like Russia are instrumental to a deal moving forward. In 2016, Russia’s involvement in the deal, along with ten other non-members, was critical to the success of the production cuts.

But just two weeks ago, Russia did not seem keen on continuing oil cuts, with President Vladimir Putin saying the state’s budget was based on oil at $40 per barrel, senior Russian officials highlighting the new efficiencies of the country’s production, and Vagit Alekperov, CEO of Lukoil, saying he didn’t see a need for cuts in 2019.

But this narrative began to change over the weekend, with Russia giving new hope during the G-20 summit that they could be on board with another deal.

“Yes, we have an agreement to prolong our accords,” Putin told reporters at the G20, according to news reports. “There is no final decision on volumes, but together with Saudi Arabia we will do it.”

What does Qatar’s decision to withdraw from OPEC have to do with the deal?
Qatar’s decision to withdraw from OPEC is likely much more politically motivated, in part to stand up to demands made by Saudi Arabia and to fully align itself as a gas exporting country, as opposed to an oil exporting country (its oil reserves have been on the decline for years).

In fact, Jim Krane, a Fellow in Energy Studies at Rice University’s Baker Institute for Public Policy, says Qatar might join the cuts as a nonmember to avoid accusations of ‘free riding’ on an improved oil sector.

“Given that possibility, Qatar might agree to voluntary cuts in line with OPEC, to demonstrate that its departure has little to do with an unwillingness to accept its share of the burden,” Krane said.

Potential Outcomes

New Deal on Production Cuts

OPEC and the non-OPEC members of the Declaration of Cooperation could agree to a firm cut in production yet again, with OPEC”s Economic Commission Board reporting that they need to cut output by 1.3 million barrels per day to avoid a supply glut and to hopefully restore balance to supply and demand for next year.

Again, however, pressure from Trump to nix a deal could put firm production cuts in jeopardy.

“The details are now what matter – how much will be cut, from when, for how long and, crucially, from what baselines,” Brower told Bloomberg after Russia agreed to the deal.

Soft Deal on Production Cuts

To placate Trump, but still cut production, OPEC could agree on softer production cuts, in which no official terms are set, but production declines are based on consumption. In this deal, OPEC producers could produce less because customers are buying less.

The strategy could appease Trump, but it might not appease oil traders, who might not see a real deal in the works. Additionally, no hard caps would make enforcement of a ‘deal’ impossible, and so the result could be less than effective.