The geopolitics and economics of oil appear set to collide at this Friday’s OPEC meeting and Saturday’s follow-on OPEC/Non-OPEC Ministerial, as members of the producing cartel and non-OPEC member countries debate the fate of the production curtailment agreement in place since 2016.
However, the biggest elephant in the room won’t even be there. The United States, while not a member of OPEC or the non-OPEC group that agreed to the cuts, has, and continues to play, an outsized role in the oil market because of both the continued strength of US shale and the actions of the Trump Administration.
The OPEC and non-OPEC production cuts agreed to in late 2016 have been effective in reducing supply on the market and thus pushing up the price of oil to a level many producing countries are more comfortable with. Brent has hovered above $70 for the past two months, up over 170 percent from its 2016 low. Additionally, oil demand has been growing at a faster clip than expected because of a robust global economy.
As production cuts have brought Organization for Economic Cooperation and Development (OECD) oil inventories back down to their five-year average—the originally stated goal of the agreement—Saudi Arabia and Russia have aligned to advocate for a production increase, arguing that maintaining the cuts could result in a deficit and overheated market towards the end of the year. An early Russian proposal suggested a 1.5 million barrel per day production increase, effectively wiping out the 2016 cuts, while just today Saudi Arabia suggested adding 1 million barrels per day to the market.
Saudi Arabia and Russia may have a shared interest in removing the limits to production, but Iran, Iraq, Venezuela, and Algeria are against the increase. With a limited ability to boost production, these countries would only experience the downsides of a drop in prices, not the upsides of selling more barrels. While a unanimous decision is required for a new agreement, many analysts expect a “coalition of the willing” to agree to a smaller increase from 300,000 to 600,000 barrels per day. New reports today suggest Iran could agree to a compromise agreement of a smaller increase that would still stay in line with the 2016 cuts by addressing “overcompliance” with the deal.
However, while the discussion will take place—and ostensibly the decisions made—by OPEC and non-OPEC representatives in the room, the role of the United States in these discussions should not be underestimated.
First, US shale production, which played a large role in OPEC’s 2016 decision to cut production, has been resurgent over the past few months as oil prices have climbed. The US rig count is up 15 percent over the past six months and US production is expected to grow by over 1 million barrels per day this year. Market share is always on the mind of OPEC producers and cutting prices by increasing production will prohibit development of some higher-cost plays in the US, leaving more room for Saudi, Russia, and others to fill the demand vacuum. This is the primary driver of Russia’s desire to increase production. (It is important to note that shale producers have proved to be lower cost than many initially anticipated as lower oil prices have spurred efficiency and innovation).
Second, geopolitics have retaken center stage. Venezuela and Iran are aligning in opposition to a production increase as a response to US foreign policy and perceived US meddling in the oil market, not to mention the fact that both countries have little to gain from ending the production limits. The potential for additional sanctions on Venezuela risk a further deepening of the draw on global inventories. The US withdrawal from the Joint Comprehensive Plan of Action (JCPOA) and re-imposition of sanctions against Iran is expected to take 350,000–500,000 barrels per day off the market. Saudi Arabia has said it would raise production to offset these losses, reportedly at the urging of President Trump. In response to President Trump’s two tweets blaming OPEC for increasing the oil price, the Iranian oil minister has said, “President Trump thinks that [he] can order to OPEC and instruct to OPEC to do something. It’s not fair, I think, and OPEC is not a part of the Department of Energy of the United States.” Both Iran and Venezuela have insisted on discussing US sanctions at the meeting, but this has been rejected by OPEC Chairman Barkindo.
Third, US threats to engage in trade wars have shaken markets. While oil demand is expected to grow at a healthy pace, a downturn in the global economy, particularly due to reduced trade and shipping, will cut into demand, undermining some of the rationale for production increases in the first place. If the prospective trade war escalates over the next three months as new OPEC barrels come to market, the conversation at the fall OPEC meeting will be very different.
Given Saudi Arabia’s insistence on increasing production along with the UAE, Kuwait, and Russia, it seems all but guaranteed that there will be more oil on the market in the second half of 2018. It is worth watching whether OPEC succeeds in its effort to further integrate the non-OPEC countries into its decision making. A fractious meeting could undermine this effort, but success on this front could ease the way for further cooperation.
Whether or not OPEC reaches an agreement or Saudi, Russia, and a few others break with the group and increase production on their own, Saudi will have scored a victory by punishing its regional rival through cooperation with Russia, Iran’s ally on so many other issues. The fact that this would be at least in part driven by the Trump Administration’s quid pro quo with the Saudis on the JCPOA, as well as the strength of US shale, underscores the outsized role the US played in a negotiation it was not officially part of.
Randy Bell is director of the Atlantic Council Global Energy Center.
Image: Entrance of OPEC Headquarters in Vienna (© Vincent Eisfeld).