Energy

Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

Saudi Arabia's policy-makers will no doubt be relieved as the much-hyped OPEC/non-OPEC output freeze unravels. The last thing the kingdom wanted was the oil price rising to a level that allows high-cost projects to move forward.

The meeting in Doha to formalize the freeze ended in failure with Saudi Arabia refusing to agree unless other nations, particularly Iran, joined from the beginning. Iran, the one country with the determination and ability to boost output this year, wasn't even at the gathering.

Iran and its neighbor Iraq have together added more than 1 million barrels a day to their crude oil exports in the first two weeks of April, compared with their March average. For Iraq, much of that comes from restoring disrupted Kurdish exports, but for Iran it's part of an ongoing drive to restore output to its claimed pre-sanctions level of 4 million barrels a day.

Export Surge
Month-on-month change
Source: Bloomberg
Apr '16 data for first two weeks

These increases offered Saudi Arabia the perfect excuse to refuse to freeze its own output. The kingdom's spokesmen, whether Deputy Crown Prince Mohammed bin Salman or oil minister Ali Al-Naimi, have said repeatedly that Saudi Arabia was prepared to act to support oil prices only as part of a broad coalition of the major oil producers inside and outside OPEC. Without that joint action, the kingdom, like other producers, will act in its own interests.

The two months of preparation for the Doha meeting contributed to a 35 percent run-up in crude prices and that's probably about as much as Saudi Arabia was comfortable with. It might have been enough to prevent some small U.S. shale producers from sinking but was too little to prompt the big and expensive projects also in Saudi sights. After this weekend's failure in Doha, oil prices will probably give up much of that gain anyway.

Cheap, But Effective
Brent has risen as much as 34% since producers started output freeze discussions in mid-February
Source: Bloomberg

The kingdom launched OPEC on a policy intended to shake high-cost oil out of the market in November 2014. To date that policy has cost producers an estimated $315 billion of their foreign-exchange reserves. Throwing high-cost producers a lifeline just as the policy is beginning to deliver concrete results would be to pour those billions of dollars down the drain. By prevailing with the policy, that money -- and the billions more that will have to be drawn down before the market re-balances -- becomes an investment in securing future market share for low-cost production.

And the policy is working. The International Energy Agency sees non-OPEC oil supply falling by 1.1 million barrels per day between the fourth quarter of 2015 and the fourth quarter of 2016. Six months ago it saw the drop at just 400,000 barrels. And three months before that, in July when it published its first detailed forecast for 2016, it actually saw non-OPEC output rising by 0.5 million barrels per day over this year.

Policy in Action
IEA forecasts of change in non-OPEC supply between 4Q15 and 4Q16
Source: IEA, Bloomberg

With oil production still running ahead of demand, this would be an odd time for the world's low-cost producers to throw a lifeline to high-cost rivals. Having been drawn into a process that flies in the face of all it's worked for over a year and a half, Saudi Arabia probably won't shed any tears as it falls apart.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Julian Lee in London at jlee1627@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net