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What Chance a Production Freeze?

Saudi Arabia and Russia increase pressure on Iran
This article appeared in Vol. 13, No. 2 - 2016

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In February Russia and Saudi Arabia agreed to freeze oil production at the January 2016 level, but only if they are joined by other large producers too. The deal came as a big surprise and pushed oil prices lower, as many market players had hoped for a substantial cut that could help restore the balance in the market and push oil prices higher. This was the first coordinated move by oil producers to try to reduce the vast supply glut triggered by the OPEC strategy change announced on 27 November 2014. 

The deal was reached at a meeting in Doha, where OPEC members Venezuela and Qatar also joined the agreement. The effect of the deal is still uncertain, however, as vital players such as Iran and Iraq, which are seeking to ramp up production to improve their economic conditions, have yet to sign the accord, and are unlikely to do so. In fact, Iran is expected to increase production by around 700,000 to one million barrels a day this year and extend production capacity by another 2 MMbopd by 2020, as a result of the lifting of sanctions on the country’s oil industry in January. Without support from Iran and Iraq the deal will have limited impact on the market. 

What if all OPEC countries and Russia were to freeze their production at January’s level: would oil prices increase sharply then? 

Source: IEA and Nordea Markets Global oil supply reached 96.5 MMbopd in January, around 2 MMbopd higher than global oil demand – indicating the supply glut will continue to increase if nothing is done to slow oil output growth. In contrast, if all OPEC countries and Russia agreed to freeze crude oil production, global oil supply (IEA forecast 96.1 MMbopd) would still outbalance global oil demand in 2016 (IEA forecast 95.6 MMbopd), but only by 500 Mbopd. This could potentially push oil prices slightly, but not radically, higher as the market would still be oversupplied. If the producers are looking for a real bounce back in oil prices in the short term to a level some OPEC members have indicated would be an acceptable price – around US$60 a barrel – we need to see a real cut in oil production. A freeze would not be enough. 

It is still uncertain whether the deal will gain wider acceptance from other vital oil producers. By suggesting a freeze to output at January’s level Saudi Arabia and Russia are putting heavy pressure on Iran to limit output growth, as the country is the only producer apart from Saudi with a substantial production cushion to talk about and the ability to increase production markedly in 2016. If the deal is not accepted by other producers, oil prices are expected to remain at the current level of around US$ 33 per barrel in Q1, as it is hard to find drivers that can push prices significantly higher in the short term.

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