Stop Production for Oil Price Recovery

Achieving an agreement on oil production cuts within OPEC has yet to reach its conclusion, but the twists and turns are plentiful. Throughout this year, the members of the oil cartel have been trying to agree on how to make oil prices on the global market start to rise more significantly, but it has turned out that no one is particularly enthusiastic about the idea of reducing production. The main problem is Iran, which has recently had long-standing sanctions lifted, and therefore wants to restore its production and regain customers at all costs. Saudi Arabia, as the largest producer, is willing to make certain concessions, but evidently not enough for others, and in the meantime, a problem with Iraq has also emerged. At the beginning of the year, a framework agreement on limiting production was reached, but a few months later, that first attempt failed miserably after the Saudis concluded that they were bearing too large a share of the production cuts. In a new round of arduous negotiations at the end of September in Algeria, an unofficial new framework agreement was reached to limit the cartel’s daily production to 32.5 to 33 million barrels of oil, which is expected to be formalized at the end of November, but Iran’s consent is crucial for success, and that is by no means guaranteed. Moreover, the latest news speaks of an intention to increase production in the cartel’s third-largest member to four million barrels per day, complicating the agreement at the end of this month despite the hopes of Oil Minister Bijan Namdar Zanganeh that a final agreement will be reached. The problem with the last ‘agreement’ is not in agreeing on the goal, but in the method of reaching it. It is not clear who should and by how much reduce production to maintain the desired production level.

Negotiating Arguments As reported by Bloomberg, Iran is seeking as much as $200 billion in investments for its neglected oil sector, which has long languished under sanctions. Convincing a country with significant economic ambitions achievable only with generous oil revenues to agree to a low level of production will be very difficult, especially considering the recent creeping rise in barrel prices despite the absence of a real agreement among producers. Speculation that Iran could be exempted from the cuts planned for November gives hope, but now the problem of Iraq has also emerged, a war-torn country that needs every dollar of oil revenue to establish control over its territory and rebuild. Iraq would also like to be exempted, and since they are the third and second largest oil producers in OPEC, this complicates matters significantly. Analysts believe that increasing pressure could serve as a negotiating argument, meaning that members are trying to enter negotiations from the best possible starting position (with the highest possible level of production, which they will then generously agree to reduce with maximum demands). And while all eyes are on Iran, whose position largely determines the future price of oil, affecting every economy on the planet, Iraq thus becomes a new obstacle to a usable agreement. The second-largest producer recently called on a number of media and organizations to assess the level of oil production, which can be interpreted as a prelude to wrangling over actual production levels at the meeting at the end of this month. Unofficial information speaks of Iraqi dissatisfaction with the production limits and the methodology for determining production levels, which, according to Iraqi Oil Minister Jabbar Ali al-Luaibi, underestimates Iraqi production.

Nevertheless, even this principled, failed, and now unofficially revived agreement has led to a slow recovery in the price of oil barrels to around $50, after at one point it sank below $30 and threatened to drop below $20, which would have called into question the basic profitability of oil extraction. On the other hand, if a convincing agreement is not reached, the price recovery could stall and start moving in the opposite direction again, as the current level is largely conditioned by hope for an agreement. If it becomes clear that there will be no agreement, the market could react extremely negatively.

The Trio Holds the Key Some better news has come at the end of October in the form of a reduction in existing stocks in the American market, or a larger reduction than expected, which immediately caused a slight increase in the price of oil barrels. The next factor that, paradoxically, works in favor of the desired production cut is the unstable political situation in Venezuela, where President Nicolas Maduro is increasingly struggling to maintain control. Production in that OPEC member has been declining for some time, and the deepening political instability and existing economic problems could lead to a larger, unintentional drop in production. Regardless of these developments, the key remains in the hands of OPEC, specifically the three largest, Saudi Arabia, Iraq, and Iran. As things stand, exemptions could include Iran, Nigeria, Libya, Venezuela, and Indonesia, and now Iraq, which could drastically reduce the relevance of the agreement. In other words, others, especially Saudi Arabia, would have to compensate for the absence of the aforementioned with their reductions, which is very questionable.

For countries that do not generate significant oil revenues, such as Croatia, the consequences of low oil prices are generally positive, at least in the short to medium term. Clearly, fuel is cheaper, which positively affects the economy, while end consumers typically feel the benefits of low oil prices last or not at all. Fuel prices at gas stations tend to rise quickly when oil prices on the global market rise, but fall slowly when they do. Similarly, traders and producers quickly feel the drop in price in the lower cost of their inputs, but they are generally in no hurry to pass those gains on to consumers who have meanwhile become accustomed to higher prices, although it should be noted that the effects vary from sector to sector. The effects for the Croatian state are twofold; on one hand, it loses on excise duties due to the lower fuel price, but on the other hand, it gains in terms of improving the broader economic picture and lower oil import prices.

Market Imbalances In the long term, persistently low oil prices can exacerbate deflationary trends, which in any case is not good for the economy as it leads to delayed purchases and investments. Likewise, the price of oil, which is a product of imbalance in the global market (excessive stocks in this case), can produce more negative effects for everyone in the long run, both oil producers and oil importers. Ultimately, every market imbalance sooner or later proves negative in the broader context of things and the global economy. Although some analysts consider the current price a possible new equilibrium, it does not reflect the alignment of supply and demand, and therefore cannot be a new balance. Stocks and production are excessive, and the current demand cannot absorb them, and according to forecasts in the short term, the global economy will not need much more oil than it does now for some time. The real price, therefore, should be higher than the current $50 per barrel, but the commodity market will only react with a price increase when it senses that the fundamentals are aligning with the market, i.e., that production is falling and stocks are significantly decreasing.