Why the OPEC cannot call for production cuts…
As the OPEC meets for its routine meeting in Vienna, the topic of discussion is something entirely contrary to what has been happening in the last one year. Since November 2014, the OPEC led by Saudi Arabia decided to protect their market share instead of worry about prices. As a result, the price of crude over the last one year has fallen from $110/bbl to $43/bbl. But why talk of cutting OPEC supply now?
It is about Middle East economics…
Economies in the Middle East have seen their macros going for a toss in the last one year. In their effort to maintain market share, the Middle East nations have seen their budget deficits widen and their forex reserves depleted. The largest oil producer in the Middle East, Saudi Arabia, now has a budget deficit of 23% and its forex reserves have depleted by $100 billion in the last one year. It is estimated that at this rate, Saudi will run out of cash in 4 years. Obviously the state of other economies in the GCC is more delicate.
But how much can they influence?
The bigger problem is that OPEC’s influence in global oil markets is waning. At one time OPEC’s share was well over 50% of global output, but now it is below 40%. Saudi Arabia and other OPEC nations fear that if they cut OPEC quotas and the prices of oil rise then it may only end up making many more shale wells in the US viable. That is the last thing that the OPEC wants. OPEC would be happy as long as a majority of the US and Canadian shale wells stay idle due to low prices.
Currently, the US is the largest producer of oil followed by Saudi Arabia and Russia close behind. Therefore Saudi Arabia realizes that if OPEC production cuts have to be successful, then important non-OPEC nations will also have to play ball. That will include Russia and to a lesser extent Mexico who are the 2 significant non-OPEC players in the oil space. Unless Russia and Mexico participate and agree to cut production in line with OPEC, the cut in output may only help the US.
The West Asia Factor…
Russia’s consent may largely depend on the outcomes and interests in Syria. Russia and Iran want Assad to stay on in Syria while the US, Turkey and Saudi Arabia wants Assad to be removed. There is unlikely to be a compromise on this subject, either by Russia or by Saudi Arabia. More so after the relations between the two factions have become frigid in the light of Turkey shooting down a Russian fighter jet.
Saudi Arabia is likely to push for an OPEC quota only if Russia supports. In the current geopolitical scenario, it looks highly unlikely. But then politics and economics is the art of the possible! ©
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