WHY THE OIL DEAL IS NO BIG DEAL

To tackle the supply glut in the oil market, producers need to cut, not cap, their current production. This is not happening even in a best case scenario wherein Iran and Iraq fall in line with Saudi Arabia, Russia, Qatar and Venezuela, and everybody commits to a global deal

On Tuesday, Saudi Arabia and Russia, along with Qatar and Venezuela, decided to freeze their oil production at January 2016 levels, so as to stabilise oil prices, which have plunged in the past two year because of a supply glut. From a high of $115 per barrel in 2014, prices were down to $27 per barrel this January, and if the markets continue to be so awash in oil, it is possible that the prices would go down to $20 a barrel.

The impact of this price drop on oil-producing and exporting countries, which depend heavily on petrodollars to fuel their economy, needs no explanation. Indeed, the situation had become so dire that even resource-rich Saudi Arabia was feeling the pinch. This forms the backdrop to Tuesday’s deal.

The deal is the first in 15 years between members of the Organisation of the Petroleum Exporting Countries and a country that is not part of the cartel. The deal also gains significance because the two countries leading this agreement, Russia and Saudi Arabia, are generally not on the same geo-political plane. In fact, for months, they have been competing with each other in the oil market. While Riyadh has recently stepped into Moscow’s turf and sold oil to eastern Europe, Russia has jumped Saudi Arabia in oil exports to China. Outside the oil market, the two nations are also on opposite sides in the Syrian civil war.

However, while on paper the deal seems like a major development, on the ground, it may not be that big a deal after all. There are two reasons for this.

Missing Pieces: The deal does not include Iran and Iraq — yet. These are the other major oil producers in the world, and without their cooperation, the supply side of the oil price mechanism cannot be controlled. Indeed, the activation of the deal itself is pegged to the assumption that the other players will fall in line.

Iran: Having just been freed from Western sanctions (following an agreement with the P5+1 powers on its nuclear programme) which previously curtailed its oil exports, Iran, the Opec’s the fifth-largest producer, is now looking to leverage its proverbial black gold so as to resuscitate its economy. In the words of Iran’s Opec envoy Mehdi Asali, it is, therefore, “illogical” to expect the country to freeze production.

Indeed, oil production has already been boosted, and by the end of Iranian calendar year (March 20), it is expected that production will reach a record high of 5,00,000 barrels a day. On Monday, Iran sent off its first Europe-bound crude cargo in four years. And over the next 48 hours, it exported more than 7.1 million crude barrels, setting a new record, according to the Managing Director of Iranian Oil Terminals.

Still, on Wednesday, Opec president Mohammed bin Saleh al-Sada, who is also the Qatari Minister of Industry and Energy, met with Iranian Oil Minister Bijan Zanganeh to discuss a freeze by Tehran. They were joined by the Venezuelan Oil Minister and the Iraqi Oil Minister. While Iran did not commit to a freeze, it still took a positive stance on the issue. “The decision ... to stabilise the market and prices for the benefit of producers and consumers, is supported by us,” Mr Zanganeh told the official news agency after the meeting.

This means that while Iran may have publicly dismissed the idea of a production freeze for now, it may eventually still agree to some sort of a special capping arrangement. This will be for two reasons — First, Iran too is adversely affected by the  low prices, and second, it will only be able to increase production overnight to a certain level; beyond that, it will require large-scale, long-term investment, forcing its production abilities to plateau in the meantime. Hence, if the other producers make a good enough offer to Iran at the point, Iran is expected to at least consider it in all seriousness.

Iraq: In the popular imagination, Iraq may have been written off as besieged by the Islamic State terror group, but on the ground, it has made some significant recoveries and simultaneously also ramped up oil production. In January, Iraq’s output was a record 4.35 million barrels a day, and the International Energy Agency estimates that this figure may still increase. Sure, there are doubts about transporting the oil out of the country but even then, Iraq remains a major player. For now, Iraq is amenable to the deal and can be expected to officially join in, if the others also commit to a cap or a cut.

Inadequate measures: The second reason why the deal isn’t going to be a gamechanger is that even in a best case scenario, with Iran and Iraq on board, it is unlikely to change the oil price trajectory in a significant manner. This is  because the deal proposes a cap, not a  cut, in current production levels. In other words, even if the deal is implemented, the market will still have a over-supply of oil.

In this context, it in interesting to note that most Opec countries, such as Russia and Venezuela, are already pumping record high levels of oil. They are stretched to the maximum, and would have had to slow down even without a deal.

And then there is America’s shale oil factor: To understand the US’s role, one needs to go back a few steps. Historically, the OPEC cartel has managed to keep a strangle-hold on oil prices because demand far outstripped supply. The shale oil boom in the US, however, threatened to change that dynamic. Opec responded by striking at the one major weak point in the shale story: The relatively high-cost of production. The oil cartel pumped up production and deliberately depressed oil prices, hoping that American shale would become unprofitable in comparison.

While the shale industry did feel the pressure, the impact wasn’t as intense as Opec had calculated especially as shale prices continued on a downward path. Any let up at this point in the Opec’s efforts to keep oil prices low will give US shale companies just the breather they are looking for to get back into business.

Past experiences: A third problem with any Opec deal is cheating. In general, Opec members are not particularly transparent with their production figures and this leads to mistrust within the group. Non-Opec members are no better either. The last time there was a global deal of this sort — in 2001, when Saudi Arabia convinced Mexico, Norway and Russia to commit to production cuts — Russia went back on its word and, in fact, raised exports.

This oped was published in The Pioneer on February 18, 2016