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Saudi Arabia Lays Down the Law to the Oil Market

Saudi Arabia called out the cheats at yesterday’s OPEC meeting — the countries that hadn’t fully reduced oil output in May as agreed — and extracted promises that they would compensate with even deeper reductions in the third quarter. Now the kingdom faces the group’s perennial problem of enforcing those promises.

The meetings of the Organization of Petroleum Exporting Countries and the bigger OPEC+ group, which includes Russia and nine other countries, were the shortest and least controversial since the latter collective was formed in 2016. It’s not that there was no drama; it just all took place in the days before the virtual gatherings.

The drama centered around the failure of key countries to make all the output cuts they had promised when the group met by videoconference the previous month. Of the 20 countries participating in that deal, 19 agreed to reduce their production by 23% from agreed-upon baselines. Only Mexico held out, and eventually the others gave in to its demand for a smaller reduction.

Saudi oil minister Abdulaziz Bin Salman obtains promises from OPEC’s laggards

When the May production estimates started coming in, however, it became abundantly clear that several countries hadn’t fulfilled their promises. That’s not unusual — but what followed was.

Saudi Arabia was done turning a blind eye to the cheats. It spent a week threatening and cajoling them. In the end, as well as agreeing to extend current output targets through July, the other countries promised to compensate for the barrels they failed to remove in May, and would fail to cut in June, by making deeper cuts in the third quarter.

Four countries, in particular, were held to account — Iraq, Nigeria, Angola and Kazakhstan. Iraq and Nigeria have long histories of failing to make the cuts they promised under previous OPEC+ agreements. Angola’s production last year was well below its target, and Kazakhstan met its obligations on average over the period, thanks to maintenance and unexpected outages at its biggest oil fields. But neither cut quite as much as they had pledged last month.

Iraq especially angered the Saudis by admitting that, not only had it failed to meet its obligations in May, but it wouldn’t be able to get output down to its target level  until the end of July. On the other hand, Nigeria had insisted that its production numbers were reported incorrectly by the secondary sources that OPEC relies on to monitor production, but its oil minister eventually admitted in an Instagram post that the country had cut production by 216,000 barrels a day — 52% of the reduction it had promised.

All four countries eventually agreed to the principle of making additional compensatory output cuts in the coming months. The real tests will be whether they do, and how Saudi Arabia reacts if they don’t.

Demand Slump

Back in March, when Russia refused to accept deeper output cuts championed by Saudi Arabia, the kingdom threatened to bring the whole OPEC+ edifice crashing down, rather than go on without Russia’s full participation. Russia called Riyadh’s bluff, and the Saudis proceeded to boost their oil production to more than 12 million barrels a day in early April — just as the destruction of global oil demand by the Covid-19 pandemic reached its peak.

The kingdom seems to have threatened to do the same again, if it didn’t get its way ahead of Saturday’s meetings. But Iraq and Nigeria learned from Moscow’s mistake — at least well enough to say the right things to appease Saudi Arabia.

Nigeria may be able to meet the new goal, as it will be aided in the task: Maintenance being conducted on at least one of its major offshore oil fields means production will run at reduced rates and shut down completely for several days. Iraq, though, will find it more difficult. In fact, I don’t see any way that it can meet its obligations by the end of September.

Assuming its production falls steadily between now and the end of July to reach its target level, Iraq would still have to reduce output in August and September by more than 1.3 million barrels a day from what it pumped in April — taking production down to a level not seen in six years. That is going to be a very tough sell for the newly installed government in Baghdad.

OPEC and OPEC+ only have more promises from those countries to make deeper cuts. The organizations have no mechanisms to enforce them.

But after the disastrous meetings in March and April, Saudi Arabia looked strong in the run-up to Saturday’s gathering, holding Iraq and Nigeria to account. Maybe those countries will find a way to do what they’ve promised. But even if they don’t, it might not matter so much. Because by demanding extra cuts and getting promises that they will come, the Saudi oil minister has sent a warning to other would-be backsliders: They, too, will be called out if they fall short.

Plus, the oil market could look very different by July. Brent crude is already above $40 a barrel, demand is slowly recovering and supply has been reduced significantly. They may be able to meet their promises simply by maintaining cuts while others slowly increase output.

For now, Saudi Arabia has shown that it can exercise a degree of authority over the other OPEC members and instill some discipline, or promises of it. Even that is a big step toward restoring credibility to OPEC and OPEC+ after a couple of bruising meetings earlier this year.

SOURCE: bloomberg