Plans To Talk Up the Oil Price Backfired
The danger of trying to manage oil price expectations with largely meaningless output-limiting agreements, as oil-producing countries tried to do in Doha on Sunday, is that the talks may fail and the publicity may turn negative. That's what's happening now: Brent crude dropped up to 7 percent after the weekend's meeting failed to produce a deal.
The oil market's reaction to the news shows once again how the price has little to do with supply and demand, and everything to do with geopolitical guesswork and knee-jerk reactions to news.
The representatives of 16 oil-producing countries, responsible for about half of global crude output, expected to agree to a production freeze at January levels, close to record highs for major producers such as Saudi Arabia, Russia and Iraq. It would have done little to reduce the global oil glut, but speculators would have driven the price up simply on evidence of cooperation among the producing countries, something that has been sorely lacking in the last two years as the Organization of Petroleum Exporting Countries pretty much let its members do as they please.
The deal, however, was scuppered by a country that was absent from the talks -- Iran. Tehran refuses to cap production until it reaches the pre-2012 level. Capping earlier would render meaningless Iran's efforts to get international sanctions lifted by compromising on its nuclear program. Iran's output has been rising sharply in recent months:
In January, the U.S. Energy Information Administration estimated Iran's output would reach 3.3 million barrels a day by the end of this year. It's already almost there, though; it appears Iran can move faster than analysts expected.
For Saudi Arabia, which says it's capable of boosting output by at least another million barrels a day, letting Iran do this makes little sense. It's not just a matter of the two countries' geopolitical rivalry, which makes it difficult for them to agree on anything. The whole point of Saudi Arabia pumping as much oil as it can is to maintain or, hopefully, gain some market share -- mainly at the expense of upstart U.S. shale oil producers, but, in the end, by any available means. The Saudis' production as a share of global demand has been rather steady in recent years, and share gains have been hard to come by.
Letting Iran add 600,000 barrels a day to its output while committing to a freeze, even at a high production level, is hard for the Saudis to swallow. It's messing up their math for this year.
According to OPEC's latest forecast, global demand for crude oil should reach 94.18 million barrels a day this year. The organization calculated non-OPEC output would drop by 730,000 barrels a day, helping OPEC increase its share of the total supply of 95.7 million barrels a day. If Iran keeps raising output, though, it will cover most of the decline and the Saudis will get nothing out of their dumping strategy apart from a budget deficit of 19 percent of gross domestic product. As this Bloomberg Gadfly column noted, Iran can balance its current account at a much lower price level than Saudi Arabia, though the kingdom's foreign exchange reserves are far greater, making it better able to plug the hole in its accounts.
Before the Doha meeting, the Saudis were hoping Russia and Venezuela, two Iran allies, would persuade the Iranians to go along with the freeze. Both these countries are interested in a global deal because they can't quickly expand production, anyway, and they need the price-raising publicity. Yet not even their influence could persuade Tehran to give up the much-needed new fiscal revenue.
That explains the lack of a deal in Doha, but perhaps not the sharp market reaction (Brent crude is now about 7 percent off its April 12 high).
The market would have remained oversupplied even if Iran had gone along with the deal. About 1.5 million barrels of oil a day more than the world needs is being pumped now. Iran could increase this gap by about 40 percent, but, to put this in perspective, the gap would only grow to 2.2 percent of global output from 1.6 percent. It doesn't change the fundamentals of a flooded market that only a big washout of high-cost, high leverage U.S. producers, or a much less likely big OPEC output cut, can balance.
Any impact from an output-limiting deal would have been purely speculative. The Saudis are willing to sacrifice that positive buzz to their medium-term strategy of keeping production up so that higher-cost producers choke. Other countries which counted on the effect of good news from Doha -- such as Russia, whose energy minister, Alexander Novak, has complained about Saudi intransigence -- may be exasperated, but this is not their game. The Saudis decided to pay dearly for reshaping the market, and they'll set the rules and hope to outlast those who don't follow them.
Since no deal, not even a symbolic one, is now likely before the OPEC meeting in June, the oil price is now likely to shed the gains caused by the expectations of an output cap. Oil-producing countries have yet to come up with a foolproof way of raising prices, while preserving the high volatility that keeps investors away from expensive oil projects in the U.S.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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