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OPEC's decision to increase production quotas not to affect market prices significantly

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01.07.2018

Despite regular heated debates about the viability of the Organisation of the Petroleum Exporting Countries (OPEC), its decisions still have a significant impact on energy markets and keep the national economies in suspense. Today, oil prices are sort of “weapons of mass destruction” capable to affect financial stability of most countries in a short period of time. Therefore, the hype and attempts of political pressure from the big powers before the June meetings of OPEC and OPEC+ were expected.

At the same time, both energy officials and experts do not expect that decisions taken to increase production to the levels stipulated in the agreement reached at the end of 2016 will have a significant impact on oil prices. Accordingly, there should not be any problems in the implementation of the amended version of Azerbaijan’s state budget for 2018, as the growth of revenues and expenditures of the state treasury was focused precisely on the increase in the price of oil.

 

Optimal option

As the market expected, OPEC member states agreed to increase production 1 million barrels per day (bpd) starting from July 2018. Although experts indicate that a number of exporting countries such as Iraq, Venezuela, and Mexico are likely to be unable to rapidly increase production, in the second half of 2018 the real increase will be 0.6-0.8 million bpd.

Anyway, the decisions compensate for the decline in oil production in Venezuela, Angola, Gabon, Equatorial Guinea, and Qatar that occurred over the past year and a half. Therefore, in May 2018, OPEC members reduced oil production by 58% more than required by December 2016 quotas. As explained by the Saudi Energy Minister Khalid al-Falih, OPEC members cut production by 2.2 million barrels instead of 1.2 million barrels. The agreements reached on June 22-23 make it possible to return to the production level of 32.5 million bpd.

In fact, global production opportunities are extremely asymmetric and almost completely concentrated in Saudi Arabia. Currently, the kingdom can produce more than 2 million bpd, while Iraq, the UAE, Russia, and Kuwait have free capacities of 200-300 thousand bpd each. Untapped capacities in the rest of the countries reach tens of thousands barrels only. Therefore, OPEC decisions do not specify quotas of each country, rather they include “nominal” 1 million bpd.

To justify this approach, the OPEC Technical Committee, which is a kind of economic department of the cartel, analysed the situation in the oil market and stated that “the global oil demand is set to stay strong in the second half of 2018. However, if OPEC and its allies continue to produce at May levels then the market could be in deficit for the next six months,” the report says.

 

Profitable corridor

Meanwhile, OPEC meetings held in June were preceded by rather lengthy discussions, disputes, intrigues at the highest level, which suggests a deeper underlying reason for final decisions.

The main reason is economic. Certainly, high oil prices, which replaced the crisis of 2014-2016, seem to be a salvation for all oil-producing states. But it is this crisis that once again demonstrated how uncontrollable price growth becomes a negative factor for the economic development of countries. It is suffice to recall that only when OPEC and a number of non-OPEC countries, including Russia, Mexico, Kazakhstan, agreed to reduce oil production by 1.8 million bpd at the end of 2016, the price of Brent oil rose from $45 per barrel prior to the deal to more than $80 in May 2018.

At the same time, both experts and market participants consider the $60-75 corridor to be the most optimal and indicate that further price increases could have a detrimental effect on consumers. “I think we really need to keep prices low, because high prices are hitting consumers,” the head of BP, Robert Dudley, told journalists when asked if the market needs more oil. According to him, until the end of the year, BP retains in its budget the price of oil at $55-65 per barrel.

According to the president of the Russian LUKoil Vahid Alekberov, the optimal price for oil is $75 per barrel. “I believe that the price of $75 per barrel is a balance that is already groped,” he said adding that at this price, oil producers can start increasing their production without fear of a sharp decline. “If the production increase affects for a short period of time, it will recover in the medium term because oil consumption in the world is growing, and commercial reserves are rapidly declining,” Alekberov said.

In fact, high oil prices negatively affects the global demand forcing consumers to switch to alternative fuels or renewable energy sources. This risk has already been reflected in the latest industry report of the International Energy Agency, in which the projected growth in oil demand this year was reduced by 100 thousand bpd. Also traditional suppliers of raw materials do not want their market share to be occupied by slate oil producers, who already feel comfortable at current prices.

 

Political perspective

Nevertheless, in addition to purely economic factors, oil prices are always accompanied by political intrigues. In particular, the resumption of US sanctions on the export of Iranian hydrocarbons removed about 1 million bpd from the world market. Therefore, it is understandable why Iran at the meetings in Vienna so vehemently opposed the increase in quotas. After the return of US sanctions, Iran's share fell almost twice. This means that with the current increase in quotas, countries will actually share the fate of Iran.

Iraq was also against this approach, as its foreign policy is largely oriented toward Iran. Finally, Venezuela also criticized the agreement because rising oil prices remain almost the only way out of the protracted crisis under the current government, and the growth of quotas, as already mentioned, should affect the market in the opposite direction.

As for Russia, the experts rated its position as “the most radical and mysterious.” In 2016, Russia bargained long enough before cutbacks in oil production, although it actively called on OPEC demanding such a measure. At the beginning of 2018, when talks began about increasing the quotas for production, Russia was against this scenario, fearing a new round of falling prices. This time however, Russians were not supporting just the increase of quotas for the countries. Moscow's negotiating position was an increase in production to 1.5 million barrels, which in fact means an almost complete rejection of the 2016 quotas.

Russia describes this situation as an effort not to “overstate prices artificially,” since it can strike everyone. Another explanation was actually voiced by the negotiators of Saudi Arabia and Russia at the meeting in Vienna: OPEC+ could become something more than a temporary union.

In fact, shortly before the meeting, both countries agreed to prepare a bilateral agreement on responsibility for the stability of the oil market, which will be based on their common desire for a balanced market.

Riyadh has become the main lobbyist for increasing quotas, as Saudi Arabia suffers the most from the restriction of production. The Kingdom had to limit a number of social programs and reorient itself to other sources of income.

According to Bloomberg, understanding that it will not be possible to gain control over OPEC+, Russia and Saudi Arabia are going to invite oil exporters from the OPEC+ oil production limitation agreement to a new similar structure. The only difference of the new organization will be the fact that large oil producers such as Russia and Saudi Arabia will receive more votes in it, in contrast to OPEC, where the principle “one country - one vote” applies.

However, experts are still sceptical about this scenario and believe that not many exporters will join the new organization.

On the other hand, according to Bloomberg, the US asked OPEC to increase oil production by 1 million bpd. However, before the OPEC meeting, President Donald Trump has twice expressed his dissatisfaction with the OPEC policy and rising oil prices: “Looks like OPEC is at it again. Oil prices are artificially very high! No good and will not be accepted!” According to experts, these tweets and the request for additional oil are among the strongest interventions in OPEC affairs since Bill Richardson, the energy secretary in Bill Clinton's administration, who telephoned the Saudi minister during the OPEC meeting in 2000 asking to increase oil production. Intervention has infuriated the other members of the cartel, exacerbating the split between Saudi Arabia and Iran.

But judging by the decisions adopted in Vienna, this time the US position was fully taken into account... Moreover, analysts note that if Trump's decisions on Iran remain tough, OPEC + will very likely further increase production at the end of 2018.

 

Azerbaijan to increases oil price in state budget

It should be noted that Azerbaijan, as one of the oil-producing countries, is an active participant in all processes taking place within OPEC+. Moreover, the 2019 ministerial meeting of the organization will be held in Baku on the initiative of Azerbaijani President Ilham Aliyev.

According to Azerbaijani Energy Minister Parviz Shahbazov, sharp decline in oil production in some major producer countries and the expected restrictions on market access, as well as the loss of attractiveness of the upstream sector for transnational companies due to low oil prices in recent years “promise” difficulties in meeting the global oil demand. Cooperation in OPEC+ is important for ensuring a new balance in energy market and for new investments in line with the needs of the oil industry, P. Shahbazov said.

Therefore, Azerbaijan is ready to continue supporting the development of the oil market in line with the interests of the oil producing and exporting countries. “Azerbaijan, which has fulfilled its obligations under the agreement with OPEC+, is contributing to the overall process for unifying oil production in accordance with quotas,” P. Shakhbazov said commenting on the signing of the “Declaration of Cooperation” between OPEC and OPEC+ member states.

However, it is clear that the OPEC+ decision on quotas do not affect the oil industry of Azerbaijan seriously: its share in the global oil market does not have a decisive role. But it may influence on oil prices, which is an extremely important issue for Azerbaijani economy, which depends heavily on the oil factor. It is suffice to recall the consequences of the crisis of previous years: devaluation of manat, bankruptcy of banks, decline in business activity, etc. Therefore, Azerbaijan is completely up for maintaining stable oil prices.

Moreover, the government is going to adjust the state budget from the second half of 2018 to an increase of almost 10% compared to the initial forecast. This is due to the growth in oil prices, which was laid down in the main economic document: from $45 to $55 per barrel. In addition, high oil prices make it possible to increase transfers from the State Oil Fund to the state budget.

In short, as a producer and a country with an oil-dependent economy, Azerbaijan is interested in high oil prices and hopes that they will remain at this level. Therefore, we will support any decision of the cartel if it ensures the stability of the oil market.



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