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Opec’s imperfect deal

Algiers marks a major policy shift. But the market will want real numbers soon

Saudi Arabia’s experiment with laissez-faire economics is over. Latter-day Naimism, embodied in the pursuit of market share at the expense of prices, has been scrapped. The Algiers agreement of 28 September signals that the kingdom, Opec’s lynchpin, is tired of $45-a-barrel Brent. So don’t be mistaken: Algiers is a big deal. It should put a floor in oil prices.

For most, Algiers was also a surprise. The 6% rise in Brent immediately after the meeting reflected this. None of the newswires and few of the analysts expected any agreement (though Petroleum Economist did).

But beware the haziness. Yes, the group wants to start cutting again. Yes, it has cobbled together some unity of purpose. But it is still unable to send a clear, straight message to the market.

The lack of clarity is dangerous to Opec’s own aims. Saying the group will cut, later, to between 32.5m barrels a day and 33m b/d, is fudge territory. Far better would have been to announce the lower number, even if it meant production came in higher. The output data would tell the market which members were adding, not cutting.

Instead, Opec president and Qatari oil minister Mohammed al-Sada could only offer a vague announcement, leaving the big questions unanswered: how much Iran will produce; which members, aside from the Gulf countries, will cut; and how rising Libyan and Nigerian supplies will be absorbed.

Opec has two months to figure that out before its Vienna meeting on 30 November. Until then, the market should test the resolve. Bearish momentum could build as refineries enter maintenance, US inventory holders liquidate to avoid end-year taxes on stocks, and macro-economic worries resurface, not least the US Federal Reserve’s impending interest-rate rise or a new banking crisis. Global oil-demand growth is weakening – the most recent International Energy Agency forecast for Q3 sees a rise of just 0.8m b/d.

Wall Street analysts, shocked at first, are now troubled by the opacity. Morgan Stanley says “scepticism is warranted” and points out that any cuts won’t now materialise until 2017 anyway. Citi says the deal was more rhetorical than meaningful. Goldman Sachs still expects oil prices to weaken through the end of 2016.

Timely demands

Part of the problem is that the deal is premature and needs time in the incubator. It was achieved with some full-court-press diplomacy, all centred around persuading Iran to postpone its 4m-b/d output target, and rushed to satisfy the demands of host country Algeria. Its oil minister Noureddine Boutarfa has been the intermediary in recent months between Saudi Arabia and Iran and his government desperately wanted a deal to be achieved on home soil. The prime minister, Abdelmalek Sellal, was brought in to put the screws on the group.

Algerian newspapers on 29 September proclaimed the triumph. “LE COUP DE MAÎTRE D’ALGER” (“The Algiers masterstroke”), shouted L’Expression, adding, wrongly, that Opec would now cut 1m b/d. “La Réunion d’Alger Rassure” (“The Algiers meeting reassures”), screamed the cover of El Moudjahid.

But for the few that expected some kind of deal, the outcome was much less than they hoped for. “It’s an absolute disaster,” said one seasoned Opec watcher from a major producer. Privately, Saudi advisors conceded their disappointment. To gain a real sustainable price surge, some insiders were calling for real and deep cuts. Instead of shock and awe, the market got hum and haw.

But don’t forget the context. The market was expecting nothing. As it stands now, a deal short of details still marks a major policy shift. The seal has been broken. The market’s shorts will be more nervous than they were last week. The mood music is also important. Sitting shoulder to shoulder in a small room at a briefing on 27 September, Saudi oil minister Khalid al-Falih and his counterpart from Russia, Alexander Novak, offered a united front. After the debacle of Doha, when Novak had walked from the room in anger after Saudi Arabia canned a freeze deal at the last minute, getting Russia even back in the room wasn’t easy. Since then, though, Vladimir Putin himself has put his name to a joint effort with Saudi Arabia to help oil prices.

Novak said in that briefing that Russia would freeze its output if Opec’s members could first agree among themselves. After the group’s deal was announced, he praised the “positive” decision. Now Russia must help persuade its geopolitical ally Iran to soften its own demands as the actual Opec terms are settled before 30 November.

That, after all, remains the sticking point. Iran believes it can add another 100,000-150,000 b/d in the short term, as new production from the West Karun fields comes online. And it still wants to reach 4m b/d, implying growth of more than 350,000 b/d.

Saudi Arabia still has to decide if its desperation for a deal is so great that it can ignore Iran’s ambitions. Iran has to decide if its 4m b/d target – a political target, which many doubt can be reached as fast as Tehran says – is worth ruining Opec’s best chance for a deal in years.

Libya and Nigeria, which Saudi Arabia says will alongside Iran be treated as special cases in the deal, provide the other problem. Mustafa Sanallah, chairman of Libya’s state oil company, told Petroleum Economist in Algiers that work is now underway to begin production in the long-shut Sirte basin. He is sticking to an output target that would almost double Libyan production, to 0.9m b/d, by the end of the year.

On its own, Libya’s rising production could more than fill the gap left by Opec’s proposed cuts. More oil from Nigeria and Iran would overwhelm them.

So having recovered its reason to exist – cutting to support prices – Opec faces its eternal problem: enforcement. To make its new policy stick, it needs to tell the market who will be cutting and by how much. It may need to go deeper than 32.5 b/d, let alone 33m b/d.

Above all, it needs to provide hard details, not vague assurances. After it digests the undoubted significance of the policy reversal, the market will want real numbers, soon.

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