Cutting the cake in Vienna

Author Toby Shelley

As the Vienna gatherings of oil ministers loom, attention turns to the cutting of the cuts cut cake. Will the participants in the output deal decide to ease the restraints in recognition that the market is more or less rebalanced? If they do, how generous will the relaxation be? And how will the extra barrels be shared out? Interrelated questions all.

The biggest Opec and non-Opec producers in the pact — Saudi Arabia and Russia — seemingly back a calibrated increase in production. After they met last month in St Petersburg, Saudi oil minister Khalid al-Falih spoke of “a gradual process to make sure we do not short the market in a negative way", and his Russian counterpart Alexander Novak referred to loosening controls "gradually, softly, not to undermine the fragile balance".

While the two big beasts wield an awful lot of weight, that does not mean a rise in output will be greeted with universal enthusiasm. Iran has already reminded current Opec president and UAE oil minister Suhail al-Mazrouei that the organisation adopts decisions by consensus and no single member speaks for the body, and made clear it will resist any proposal that might allow others — meaning Saudi Arabia and Iraq — to encroach on “its” market share, as it says happened during the 2012-16 sanctions.

Mustapha Guitouni, oil minister of Iran’s fellow price hawk of old, Algeria, has said he reckons prices have stabilised at around $75-80/bl and that price is fine by him, suggesting he doesn’t favour doing anything to rock the boat.

Iraq’s record on compliance has been less than perfect — although the same could be said of Russia — so its moral heft may be compromised in talks. But it too is concerned about Saudi Arabia exploiting its position as the only Opec member with substantial spare capacity to snaffle market share, leveraging its stakes in Asia-Pacific refineries.

Nigeria and Libya don’t have formal quotas because of the security situations they faced in 2016. But both will be wary of anything that threatens to reduce the revenue they get from what they can produce. Unable to meet, let alone beat, its quota, Angola too may be wary of price erosion.

If Saudi Arabia is the big beast of Opec, Venezuela will be the elephant in the room at this meeting. The ongoing implosion of its upstream industry has seen its output collapse way below its allocation, so the best it can hope for is better prices for what it can ship. Whether current, recent and shaky incumbent oil minister Major General Manuel Quevedo turns up in Vienna remains to be seen. And, if he does, it is unclear what he can contribute.

In the non-Opec camp, the only big contributors are Russia — accounting for more than half of the pledged non-Opec output cut — and Mexico. Several of the bit-part players are busting their quotas or have little control over production; their role is decorative rather than substantial.

Mexico’s cut is more a recognition of production decline than a sacrifice. Which leaves Russia. While Novak said what he said in St Petersburg, his emphasis was as much on caution as on action. Public and private-sector Russian companies are clamouring to be let off the leash. But the OECD last week said a rise in oil prices from the average level of 2017 to $80/bl in 2018-19 would represent a notional transfer from oil consumers to oil producers of around $900bn, and it picked out Russia as an economy set to gain from higher prices. The finance ministry in Moscow will want to be assured that whatever is done in Vienna, does not undercut its income.

So, on the assumption that Opec and friends do sanction an upping of output, the discussion regarding how much and how quickly to do so may be fraught. Saudi Arabia has substantial spare capacity and may be tempted to argue for a bigger increase than fellow Opec members selling into Asia-Pacific are happy with — although Kuwait might be bought off with a restart in the Neutral Zone and Iraq with a blind eye to its actual production.

But even if there is a temptation to expand market share, there is a countervailing pressure in Riyadh. Not only does the state gain from higher prices — export revenues rose by 26pc in 2017 on export volumes that were 6.6pc lower than in 2016 — but the book value of Aramco ahead of a planned partial IPO increases. So Saudi as well as Russian bean counters will be urging caution.

A back of the envelope calculation has led some — reportedly including President Donald Trump — to propose a 1mn b/d increase in output from the Opec, non-Opec crew. Novak quickly slapped that down as simplistic, as indeed it is. And, given uncertainty about the timing and extent of any reduction in Iranian exports because of US sanctions, a modest output increase in June and the customary promise to monitor the market and calibrate accordingly may be on the cards — a compromise to part satisfy price hawks and volume chasers.

Whatever the scale of a notional volume increase, there is the problem of how to divide it up, and that is a whole new can of worms. And divided up it must be — imagine the outrage if Saudi Arabia took the lot on the basis that it has been over-complying and has spare capacity. Volume increases could be allocated on a pro-rata basis — say, everyone’s cut is reduced by 10pc. But what of the non-compliant? Should those that have over-produced be accorded the same reward as those that have complied? On the other hand, what is the point of allocating higher quotas to those that cannot meet their existing allocations? And, historically, drawing up Opec quotas has been complicated by other arguments — remember when Iraq and Iran demanded parity and Kuwait and the UAE demanded parity, when poorer members argued for special dispensation?

So, any self-congratulation in Vienna may yet be soured by wrangles over the size and distribution of the spoils — assuming there are any spoils at all.

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