By Dan Steinbock
The Vienna Agreement among OPEC and non-OPEC oil producers extended oil cuts, resulting in a nearly 5 percent oil price plummet. With mounting global pressure as a result of the Vienna Deal and cuts in oil production, these measures will only serve as a short-term relief.
Among the oil insiders, the decision to extend oil production cuts was seen as a done deal well before last week’s Vienna meeting. But, investors seek assurances of longer production cuts. That is vital in an era of huge energy overcapacity.
The Vienna outcome is critical to all energy importers. But why is it that oil producers seem to restrict their debates to shorter-term cuts, even though patient capital considers longer-term cuts warranted?
The oil glut of the 2010s
The current oil glut originates from surplus crude oil in 20142015. Accelerated in 2016, it was fueled by oversupply as the US and Canadian shale oil production reached critical volumes. Other contributing factors were geopolitical rivalries amongst oil-producing nations, the eclipse of the commodity super-cycle due to the deceleration of Chinese growth, and perceived policy efforts away from fossil fuels.
As recently as 2012, the world price of oil was still above $125 per barrel and remained relatively strong above $100 until September 2014. The sharp downward spiral ensued thereafter as the oil price plunged below $30 in January 2016. Moreover, the production of the OPEC was poised to rise further with the lifting of international sanctions against Iran, even as markets were oversupplied by 2 million barrels per day.
A global oil price meltdown
As the initial OPEC meetings failed to lower the ceiling of oil production despite great overcapacity, what followed was a deep oil price meltdown. It heralded a new wave of destabilisation that contributed to diminished global growth prospects. In this status quo, the ability and willingness of the 13-member oil cartel to agree on such a ceiling were crucial in supporting stability while contributing to global growth. This may be on a temporary basis, at least as long as its OPEC and non-OPEC participants comply fully. Any new exemption or expanded production volume or ineffective compliance undermines OPECs effort to push up prices by extending cuts.
Between August 2016 and February 2017, oil prices increased by 20 percent. This was primarily because of the agreement by the OPEC and other producers to cut oil production. After some weakening, oil prices stood at $50 a barrel at the end of the first quarter, soaring to almost $55 right before the Vienna talks.
Impact of the cuts across the globe
Today, Riyadh needs stability to cope with domestic economic challenges, amid its war in Yemen. That’s why Saudi Arabia agreed on last fall to the first output cut since 2008. This meant accepting a big hit on its production while permitting its regional rival Iran to freeze output at pre-sanctions levels. The consensus was not automatic. In the past few months, Iran and Iraq- the second and third-largest OPEC producer respectively- have sought exemption from further production cuts.
Following talks, Iraqi Oil Minister Jabbar Al-Luaibi and his Iranian counterpart Bijan Zanganeh supported the extension. This was done along the lines of a plan agreed upon by Saudi Arabia and Russia, the largest OPEC and non-OPEC oil producers, respectively. A bad deal was better than no deal, in which case oil prices would plunge again. This would hurt them even more.
Russia has supported the cuts all along because, in the absence of adequate diversification, Moscow remains dependent on oil revenues. As long as the prices remain steady and on the upside, Russias economic growth is secured. The extension also benefits the United States and the Americas, due to their shale and offshore oil and gas resources.
Inadequate extensions and global pressures
However, as the post-Vienna price declines evidence, the extension is inadequate. The rebalancing of supply and demand is still seen at least some 18 months away, after the buildup of stocks over the past three years. Even before the Vienna meeting, sceptics thought that oil prices may not exceed $60 in 2017-18 because oil markets are under secular transformation, bargaining power has shifted from advanced economies to emerging nations, and new alternatives (shale, renewable) are capturing more space.
Sluggish demand will ensure that further cuts will be needed as prices will remain subdued. New pressures will ensue. When the dollar goes up, oil tends to come down. Oil is denominated in the US dollar, which is intertwined with the Feds policy rate. The Fed will continue to hike interest rates which could contribute to further turbulence, particularly in those emerging and developing economies that are amid energy-intensive economic development.
What can be expected in the road ahead?
In the short-term, the Vienna extension of production cuts is necessary but not sufficient for a sustained global recovery. Despite abundant inventories and sluggish demand, seasonal demand is likely to rise in the summer in the Middle East, which may make compliance challenging. Stronger US production is likely to delay rebalancing.
Moreover, there are several potential geopolitical storms that could undermine the ability or the willingness of OPEC and non-OPEC to sustain consensus about production cuts. These include the Riyadh-Washington military cooperation but dissension about oil markets future, the continued need for exemptions by Iran and Iraq and some other major producers, the new normal of oil demand in large emerging economies, the economic implications of President Trumps pro-Israel policies in the Middle East and so on.
Even in the most benign two-year scenario, increasing divisions about production cuts are likely to keep prices relatively subdued for a protracted period. Far more is needed for peaceful, stable, and sustained global prospects.
Dr Dan Steinbock is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore).
The original, longer version was released by The Manila Times on May 29, 2017
Featured image credits: Pexels