OPEC Edges Closer To Production Agreement

The odds of an orderly agreement in Vienna significantly increased over the last day or so as Iran appeared to soften its hard line, voicing some openness to a modest increase in production from the OPEC+ group.

Saudi oil minister Khalid al-Falih said that the oil market needs more supply because of rising demand and because of the significant outages in several countries.

“The market needs more oil than is currently being produced by these 24 countries,” al-Falih told reporters in Vienna. "Ultimately, we will meet the needs of the market. Consumers are asking for more supply in the second half."

But he went on to add that any increase should be done cooperatively with the whole group’s blessing. “We have to be sensitive to all member countries and listen to their desires,” he said. “Some have said, 'We can't produce and don't increase our production limit,' so I think we just have to wait and listen and come up with a decision that satisfies all stakeholders.”

That conciliatory tone will likely soothe some of the tensions with some of OPEC’s other major producers that have been vociferously opposed to any increase in output, namely, Iran, Iraq and Venezuela.

As of May, the group produced about 840,000 bpd below its targeted level, according to S&P Global Platts, which would seem give them a lot of room to allocate output increases to simply get back to 100 percent compliance.

The presumed solution up until now has been for Saudi Arabia and Russia to simply ratchet up their output, since many other member countries have no ability to do so. But al-Falih acknowledged the pitfalls of charging ahead without the group’s approval. “Reallocating [allocations] to other countries like Saudi Arabia may be a technical solution, but it may not be politically agreeable to others,” he said.

The cooperative tone, no doubt combined with some behind-the-scenes negotiating, appears to be working. Iran has significantly dialed down its opposition. Earlier this week, Iranian officials said they would veto any move to increase output. “OPEC is not an organisation to receive its instruction from President Trump,” Iranian oil minister Bijan Zanganeh said when he arrived in Vienna, referring to reports that the U.S. government pressed Saudi Arabia to increase output to offset expected declines from Iran.

“The US president has blamed OPEC for the price hike,” Zanganeh said on Wednesday. “Indeed, the real responsibility for the current oil price hike lies with the US president himself.”

But several days of talking seems to be building good will. “We are making good progress,” said United Arab Emirates Energy Minister, and current OPEC president, Suhail Al Mazrouei. “This is a very good meeting. We are optimistic.”

Iran’s oil minister also softened his tone, saying that he was optimistic the group could reach a compromise. He signaled support for bringing compliance back to 100 percent.

Still, the details matter, and there isn’t an obvious solution. The Saudis recognize that unilaterally pushing forward with production increases could lead to a breakdown in OPEC’s cohesion, but allocating production increases across the group, to members who have no ability to increase, might not lead to actual increases in supply.

Bloomberg reports that the Saudis are offering a convoluted proposal that would apportion around 1 mb/d of supply increases to various members, but because many won’t be able to ratchet up output, the real supply boost might only amount to about 600,000 bpd.

That echoes other reporting. Reuters hears that the group is considering a 1-mb/d increase, of which the Saudis would add between 0.25 and 0.3 mb/d. After factoring in a few hundred thousand barrels per day from Russia, plus more minor additions from elsewhere, you get to around 600,000 bpd of actual increases.

If a consensus can be reached, the Saudis will have then achieved about as much as they possibly could: They will have threaded the needle by adding more supply to the market, adding enough to keep Russia happy, but not adding so much that the oil price collapses or so much that the rest of OPEC revolts. Indeed, the addition of 600,000 bpd would merely offset the extra declines from Venezuela; it would not flood the market.

In fact, Citi’s Ed Morse says that a roughly 0.5 mb/d increase in supply would actually lead to a $5-per-barrel increase because it would be less than what the market needs.

To get Iran and Venezuela on board with the plan, there is one more carrot the Saudis could offer. Iran and Venezuela might not be able to ramp up production, but they are both pressing for an official statement of some sort from OPEC condemning U.S. sanctions and American interference.

There is a bargain to be had – OPEC could agree to increase production, a large portion of which would be met by Saudi Arabia, but the group could also offer the sanctioned members some official statement in the communique at the end of the meeting, defending their sovereignty. It isn’t clear that Saudi Arabia, a close Trump ally, would go that far, but it would go a long way to smoothing over the tension in Vienna.

Nick Cunningham for OilPrice.com