Unless the freeze becomes cuts its significance is minimal and efforts to keep talking up the market could backfire
Nothing gets the oil press’s pulses racing like signs of Saudi supply constraint – more so if it comes with whiffs of wider machination. Moscow and Riyadh doing a deal over Syria to lift oil prices? It doesn’t get juicier.
As a way to explain Brent’s 28% rise from mid-February to $40/b on 23 March, the freeze agreed between the two countries in Doha on 16 February (and including Qatar and Venezuela) looks plausible. The kingdom seems willing at last to broach supply-side management. Oil minister Ali al-Naimi says the freeze is “the beginning of a process”. On 17 April, several more producers will supposedly arrive in Doha to discuss a broader agreement.
Under any scrutiny, though, the Doha deal doesn’t cut it. It’s been a cost-free way to try to lift the market, coinciding with other underlying forces. And any genuine rally will probably be self-defeating.
First, the deal froze output at January’s high levels: for Saudi Arabia, at 10.23m barrels a day (b/d) and for Russia at 10.9m b/d. Aside from restarting the Khafji field in the Neutral Zone, Saudi Arabia can’t easily sustain higher output – its maximum operational comfort level is 10.5m b/d, including Khafji, say consultants close to the kingdom. Russia is also near its maximum.
Second, as any worthy analyst stresses – and as Naimi says – the freeze only works if others join in. Iran added 220,000 b/d to output in February and talks of producing another 0.7m b/d or so by year end. It won’t happen – but Tehran isn’t going to be hamstrung by a deal that suits rival producers more than Iran.
Under any scrutiny, though, the Doha deal doesn’t cut it. It’s been a cost-free way to try to lift the market, coinciding with other underlying forces. And any genuine rally will probably be self-defeating
Iraq has made ambiguous statements supporting Doha, but also hopes to increase production. About 0.6m b/d of its output is in the hand of Iraq’s Kurdish region, which has pre-sold much of the crude and needs the income to stay afloat. So supply constraint would have to come from the south, where the government insists production will keep rising this year.
The bigger the group joining the freeze, the less chance it has. Fifteen or so countries are now said to be prepared to deal in Doha later this month. Enforcement – and the market will be watching for cheating – would be a nightmare.
As much as the Doha dealers might want to take credit, meanwhile, oil prices have strengthened for other reasons. February tends to bring a bounce on January lows. Oil followed other commodities higher.
The market is now looking beyond refinery maintenance to the northern hemisphere’s summer driving season, when processors will maximise throughput again.
Genuine supply cuts and problems are also emerging. China will lose 200,000 b/d this year, predicts Citi, a bank. The shutting-in of the Iraq-Turkey Pipeline knocked out 0.6m b/d of supply in February, and it remains vulnerable to attacks. There’s trouble elsewhere. A pipeline explosion in Nigeria cut 250,000 b/d of Forcados production in early March. In the US, output fell by 80,000 b/d in February.
Unlike Doha’s cheap talk, these are real bullish factors. As Petroleum Economist argued back in December, 2016 would revive geopolitics as a force in global oil markets. Weak oil prices have made too many major oil producers too vulnerable, from Venezuela to Iraq, West Africa and Algeria. And they’re not a happy bunch.
The other reasons to doubt the success of an extended freeze deal this month are found in China and the US. Financial analysts are convinced Beijing will soon start devaluing the renminbi. This would inflate the cost of dollar-denominated oil imports, inevitably cutting into Chinese imports. The country has used cheap prices to stock up: it added 1.4m b/d to its strategic petroleum reserves in December alone, reckons the International Energy Agency. The pull on Opec’s crude from China could get much weaker if the renminbi drops, or indeed Doha chatter lifts oil somewhere nearer $50/b.
In the US, a sustained rally now would perk up tight oil. The country produced 13.54m b/d in February, says the Energy Information Administration (EIA) – more than in January; just 57,000 b/d less than a year earlier; and 0.53m b/d beneath the April 2015 peak. Output is falling less steeply than the EIA had expected.
Thanks to WTI’s recent rise, the oil rig count for the week ending 18 March rose by one. One new rig does not a recovery make. But if Saudi Arabia and Russia succeed again in talking up the market, drillers in Texas will be very grateful. The last thing Riyadh and Moscow want is to give US producers a price that will freeze their output too – just before it really started to melt away.
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