Is OPEC’s latest deal a compromise on politics & fundamentals?

After a long week of internal discussions, and growing conflict between Saudi Arabia and Iran, a compromise has been reached. Saudi Arabia, OPEC’s leading member, and Iran have been able to agree to disagree. The oil cartel’s decision to increase production by 1 million bpd is a way of letting off some steam, as Riyadh and Tehran have been looking at the abyss. Global oil markets, however, will be confronted the coming months with an OPEC fighting internal power politics, while dealing with Washington’s Twitter diplomacy and Asian consumer criticism.

Saudi minister of energy Khalid Al Falih, OPEC’s leading proponent of the existing OPEC production cut agreement, has been walking on his toes not to break up the cartel, while countering US president Trump’s unrealistic statements and Asian worries about price increases. The heat has been on in the rooms of the former Austrian Emperor’s palace Hofburg in Vienna during the last days. 

The current agreement to increase production by 1 million bpd should, however, not be taken at face value. In reality, additional volumes will be much lower— some expect it to be between 300,000 to 600,000 bpd in reality. The market seems to be disappointed as crude oil prices after the announcement spiked again.

The Vienna encounter, showing Machiavelli’s grand strategy approach, showed a new aspect of global oil markets. After years of only being influenced by market fundamentals or institutional investors decisions, geopolitics and theatricals re-entered the constellation. If looking only at market fundamentals, OPEC and Russia would not have been enticed to consider production increases.  Even though oil storage has reached a 5-year average, enough oil is on the market to keep the global economy growing. Demand and supply are at a tipping point but stored volumes would be able to mitigate any unexpected outages. However, geopolitics and country-specific strategies have become a main driver in the discussion at present, and for the foreseeable future. As Iranian minister Zanganeh stated: “US president Donald Trump has politicized the oil market.”

Even though other oil producers have not openly agreed to this statement, US sanctions on Iran and Venezuela are taking out several million of bpd of crude oil of the global market. At the same time, continuing civil wars in Libya, Syria and Iraq— combined with instability in Nigeria and Brazil— have a detrimental effect on full production capacity worldwide. These factors, with current cuts in place by ROPEC, have resulted in a very tight global oil market. In the coming months, the situation could become even grimmer, if Iran faces heavy restrictions. Some additional volumes will be needed to mitigate these risks.  The question, however, is who will be able to provide such volumes?

Analysts are looking look at three potential supply options, Saudi Arabia (holding a perceived 12.5 million bpd production capacity), Russia and US shale. Technically, all three are facing immense issues to fulfill these expectations.  The success of the ROPEC agreement is now also a potential stumble block in future. If the top three producers are not able to open the taps to counter possible mishaps, price hikes above $100 per barrel will be no exception.  If current compliance rates are partly based on technical issues on the main producing fields, the world is going to be heading for a “back to the future” scenario of $140 per barrel very soon. 

The current situation of geopolitics, national politics, and fundamentals is at present a volatile mix with high risks. Currently, OPEC and Russia’s main strategy is to mitigate fears in the market, while keeping a dream in place that they can flood markets if necessary. This could be a major mistake. 

A lack of upstream investments during the last decade, combined with a continuing energy demand growth, will reach a tipping point, presenting the world with a shortage of oil supply. Saudi’s Al-Falih and others are currently trying to renew the interest of institutional investors and operators in upstream— not only within OPEC, but also among non-OPEC members. Additional volumes need to be generated outside of the heartland of oil. If this is possible, energy consumers will be facing the bill.

Analysts should now be looking at two major developments: 1) one is the unofficial continuation of the ROPEC agreement as planned by Russia and Saudi Arabia. Even then, compliance rates will fall a slightly due to production increases, but the Russian-Saudi contract will be in place. 2) The other issue is the position of Iran within OPEC. Although Al-Falih has been able to twist the arms of Iran’s Zanganeh, the fight is far from over. Saudi Arabia is heading for round two leading on points, but Iran has shown stamina. A renewed confrontation between Riyadh and Tehran is to be expected as soon, as US sanctions on Iran are really going to bite. The Saudi-led block is more than able to take Iran’s market share in Europe and Asia, but this will be seen as an act of treason by Iran.

OPEC’s future, however, is not at risk due to high oil prices or lack of demand. But, regional politics have now taken prominence. Russia has taken front stage on Saturday, and will need to show its political stamina now too. Moscow’s triangular relations with Riyadh and Tehran now, more than ever, need to be used to keep the unofficial new oil cartel together. Novak and Al-Falih are now playing on the same chess table.

Cyril Widdershoven is a geopolitical and oil & gas analyst covering the Middle East and North Africa region, as well as Turkey. He is the founder and director of Verocy, a Netherlands-based consultancy.