Saudi Arabia takes part in OPEC negotiations to address oversupply of oil

Ongoing talks to reduce the global supply of oil in an attempt to raise prices have so far yielded only preliminary agreements, with Saudi Arabia and other major oil-producing nations historically unwilling to reduce their exports. However, with oil prices falling from $115 per barrel for Brent crude in June 2014 to a low of $28.50 in late January 2016, before rallying to $52 dollars as of early October 2016, government revenues around the world have been affected, leading to budget cuts in countries like Saudi Arabia and Russia in order to try to balance the books (see Economy chapter).

In mid-February 2016 four of the largest oil-producing nations – Saudi Arabia, Russia, Venezuela and Qatar – signalled that they had reached a preliminary agreement to freeze production levels to counter the oversupply of crude oil on the global market. In July 2016 Alexander Novak, Russia’s minister of energy, told international media, “We do not discuss the issues of coordination of actions between Russia and the Organisation of the Petroleum Exporting Countries (OPEC)... We can’t agree on production cuts as we don’t have such tools and mechanisms.”

Oil Price Fluctuations

With oil prices dropping to a 13-year low in January 2016 in the face of increased supply on the global market, oil-dependent nations like Saudi Arabia have faced a tough decision on whether to cut their own production and risk losing market share, or keep up high levels of production and hope that growing demand will help push prices back up.

At its June 2015 meeting, OPEC voted to maintain the bloc’s overall crude oil production at 30m barrels per day (bpd), as had been agreed at its previous meeting in November 2014. The preliminary deal among Saudi Arabia and Russia, Qatar and Venezuela to freeze oil output at January 2016 levels was seen as the first move towards reining in oil production. However, it was unlikely to make a significant difference to the global oversupply, at least in the short term, and to date the failure to implement any deal may now damage future negotiations to bring down global oil production.

Record Production Levels

The initial planned freeze was announced at a time of near-record output. Crude oil production in Saudi Arabia averaged 10.2m bpd in 2015, according to a February 2016 Jadwa Investment report, which represents an increase of around half a million bpd compared to 2014.

Saudi Arabia’s decision to step up production was in part a response to rising domestic demand, especially during the hot summer months. According to international media reports, the Kingdom pumped a record 10.67m bpd in July 2015. Saudi Aramco Products Trading Company − an arm of Saudi Aramco − had reached out to external markets in early June of that year due to the expected seasonal surge in electricity demand.

Tapping suppliers in both India and the Middle East, the company bought 1.1m barrels of gasoil for delivery in July, just ahead of the peak consumption period. Due to soaring temperatures, Saudi Arabia has been a top importer of gasoil during the summer months, but imports are set to fall as it adds capacity from new refineries. Media outlets also reported that the Kingdom’s increased output levels were due to the country’s efforts to expand its presence in the downstream segment (see Industry chapter).

Rising Export Levels

The Kingdom exported an estimated 7.49m bpd in December 2015. This represented the second-highest year-on-year increase in the past five years, albeit down by 233,000 barrels from November.

Meanwhile, Russia produced approximately 10.98m bpd in 2015, a post-Soviet era high, while Venezuela pumped 2.63m bpd and US shale production continued to grow, according to BP’s “Statistical Review of World Energy 2016”.

At the same time, Iran, on the back of reduced international sanctions, distanced itself from any production freeze and was already surpassing pre-sanction production levels of around 2m bpd. The country increased its oil production by 187,800 bpd in February 2016 to reach 3.13m bpd, the country’s biggest monthly gain since 1997, according to an OPEC report published in March 2016. This figure has risen further, with 3.65m bpd of output recorded for August 2016.

Production Cap Discussions

In March 2016 Mohammed bin Saleh Al Sada, Qatar’s minister of energy and industry and the current OPEC president, announced that a group of OPEC and non-OPEC countries would meet in Doha on April 17 in an attempt to come up with an industry-wide freeze and “put a floor under oil prices”. All together, 13 OPEC members were invited to attend the event, in addition to Russia, Mexico and five other non-OPEC nations.

At the meeting Saudi Arabia insisted that Iran also agree to cap its oil production as a prerequisite to any further discussions. Without Iran agreeing to a freeze – or at least a future cap on its production, allowing it to increase production until that point – it would be hard to convince other major oil-producing nations like Saudi Arabia to rein in their own production.

Indeed, according to the March 2016 OPEC report, oil production increased in February 2016 among the nations involved in the preliminary oil freeze agreement in Doha. Saudi Arabia saw output reach 10.14m bpd, a month-on-month (m-om) increase of 14,000 bpd, while Russian oil supply hit a new high of 11.08m bpd, adding a total of 10,000 bpd to its production. Venezuela improved production by a total of 22,000 bpd, while Qatar saw a rise of 2800 bpd. Despite these individual increases, overall global crude oil production fell to 95.7m bpd, down 210,000 bpd from January 2016, with Iraq slipping by 263,000 bpd m-o-m to 4.2m bpd and Nigeria down 94,200 bpd. The UAE also saw its oil production decline by 49,200 bpd.

Landmark Talks 

In late September 2016 OPEC member countries reached another preliminary deal at an informal meeting in Algiers, setting the output ceiling at 32.5m-33m bpd. According to press reports, the date of the output freeze is expected to be presented at OPEC’s meeting at the end of November 2016. Although the agreement made in Algiers did not set production target levels for each country, the news of a possible future cap led to global oil prices rising by more than 5% immediately after the meeting.

Oversupply Challenge

However, major questions remain over whether the freeze will actually be enacted. If it is, it will be the first time it has happened since 2008. Therefore, the issue of oversupply on the market is a matter of some concern for oil-producing nations. As of August 2016 global oil output was still short of production levels despite the fact that oil demand growth is expected to increase by 1.23m bpd to reach 94.27m bpd in 2016, according to OPEC’s latest report. This represents a slight upward revision on the figures projected at the start of the year and is due to a better-than-expected performance throughout the first half of the year.

Significantly, Iran was also present at the Algeria talks, which has bolstered hopes of reaching a production cap deal before the end of 2016. Previously, the country had shown little willingness to cut production levels, instead committing to raising output. Reportedly, the country had previously stated that while it would not participate in any production freeze agreements until it was pumping more than 4m bpd, it could be open to discussions after that time.

Without A Freeze

Some believe that market economics will ultimately correct the global oversupply, as countries where it is more expensive to pump oil will slow their production until prices rise. There are signs that this is happening; US crude production fell by 90,000 bpd in March 2016, according to the US Energy Information Administration. In an interview with the press in June 2016 Khalid Al Falih, minister for energy, industry and natural resources, said, “The oversupply has disappeared. We just have to carry the overhang of inventory for a while until the system works it out.”

The trend of higher-cost producers cutting their supply benefits the Kingdom, where oil production is among the most cost-effective in the world. OPEC’s March 2016 report predicted that among non-OPEC members, the US, Mexico, the UK, Kazakhstan, Azerbaijan, Russia, China and Colombia would see large production declines in 2016 due to the unfavourable environment, with non-OPEC supply set to decrease from 57.09m bpd in 2015 to 56.39m bpd in 2016.

While some oil-producing nations will see a drop in production due to market forces, the amount of new supply coming on-line means that some form of agreement on production caps is likely to still be needed, if major oil-producing nations such as Saudi Arabia are to escape a cycle of oversupply and price fluctuations, or perpetually lower prices.

Saudi Aramco

Officials from Saudi Aramco have said that the recent price environment has not affected their investment plans. While it is unlikely that the Kingdom will spend significant resources on exploring new supplies without bringing them on-line, the reluctance of other nations to agree to or implement production freezes or caps could slow the rollout of new supply.

For decades Saudi Arabia has played the role of swing producer, tightening exports at times of oversupply and raising them when the market could absorb them. With the Kingdom increasingly unwilling to singularly lower oil production and risk losing market share, a global agreement on capping oil production is likely to be pivotal, especially given growth in the production of shale oil and other resources, as well as renewable energy.

With a date for the OPEC production freeze expected to be announced in November 2016, there are some difficult negotiations ahead as the individual caps are set. The September 2016 agreement points to a scenario where oil-producing nations are coming together to regulate global supply, motivated by the threat of battling for ever-lower oil revenue. This has the potential to become more important in the years to come.

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