THE BLACK GOLD DEJA-VU

The April deja-vu: that was my first impression after reading the recent reports on yet another attempt of oil-producing countries to freeze the extraction of “black gold”.

The first attempt made in April 2016 was unsuccessful just a few hours before the signing of a major agreement on freezing the oil production, which was ready to be signed by 18 states, including Saudi Arabia and Russia. The main culprit of failure were the Saudis, who were unsatisfied with Iran's disagreement to freeze the existing production volumes due to lack of necessary oil production levels. At that time, the Islamic Republic only was just recovering from sanctions and actively restoring the lost positions in the oil market. The sanctions had hardly hit the Iranian oil sector: the production fell twice reaching 2 million barrels per day, and Tehran was ready to theoretically join the freezing in the future when it reaches the pre-sanction production levels. But Saudi Arabia did not want to give away its market share, hoping, on the contrary, that the agreement will limit production growth in Iran.

Whatever it might be, the original idea on freezing failed, which, however, had no effect on the market. Quotes has remained at the range of $45-50 almost without any noticeable attempts of oil-producing countries to negotiate. The expectation that the demand and supply will balance in early 2017 has played an important role in this. Indeed, the demand was growing very rapidly and even exceeded the production growth rates, despite the fall of production volumes in the US. But in the summer, both Saudi Arabia and Russia increased production to record levels, 10.6 and 11 million bpd, respectively. Iran, the UAE, Kuwait was following them during the same time period.

In parallel with this, the demand was decreasing, which was stubbornly neglected by the oil producers. According to the International Energy Agency (IEA), in the first quarter of 2016, the oil demand increased to 1.6 million bpd, then fell to 0.8 million bpd in the third quarter, which is associated with a decrease in demand in China, India and a number of European countries.

Meanwhile, the production outside OPEC countries has decreased. According to IEA, by the end of 2016, the production will decrease by 840 thousand bpd due to falling rates in the North Sea, the US and Kazakhstan. It seemed that the market is going to balance. In this case, OPEC would had only to maintain the level of production but the cartel did the contrary: it has increased production by 900 thousand bpd. Meanwhile, IEA forecasts nearly 400 thousand bpd increase in non-OPEC countries next year.

Under these circumstances, Russia and Saudi Arabia have made a second attempt to negotiate freezing. During the G20 summit, the Russian President Vladimir Putin and the Crown Prince of Saudi Arabia Mohammed bin Salman agreed on cooperation to ensure stability on the world oil market. The agreement was signed by the energy ministers of both countries, Alexander Novak and Khalid al-Falih. However, the statements of two ministers were out of tune. Novak stated the possibility of freezing for 3-6 months at summer production levels, while Al-Falih noted that the freezing was not necessary, as “the situation in the market situation was improving every day.” At the same time, the Saudis have tried to agree on freezing with Iran.

At first glance, it seems that Iran is more favorable to the idea of ​​freezing. At the meeting with the Secretary General of OPEC Mohammed Barkindo, the Iranian President Hassan Rouhani said that Tehran supports any measures aimed at the stabilization of oil prices, if they are backed up by a fair distribution of production quotas. Iran's Energy Minister Bijan Zanganeh stated that Iran would support any measures that would stabilize the prices in between $50-60. However, he later said that Iran would continue to increase production bringing it to the level of sanctions. Zanganeh said that Iran should return to its former share in OPEC, which was 13% of the total volume of oil produced by cartel. “Based on current production volumes, Iran should produce 4.4 million barrels per day”, stressed the Minister.

This statement was in fact made in response to a proposal by Saudi Arabia to reduce the overall level of OPEC production by 1 million bpd, of which 400 thousand bpd would have been produced by the Kingdom. At the same time, the Saudis put forward the condition that Iran must freeze production at the level of 3.7 million bpd.

As a result, the expected informal OPEC meeting in Algeria, where the decision on freezing should have been made, has become only a consultative meeting with cartel ministers discussing the current situation in the market to prepare solutions for the November OPEC summit. That is why a number of oil-producing countries that are not members of the cartel, including Russia and Azerbaijan, did not take part at the meeting in Algeria. According to the Russian Energy Minister Alexander Novak, Russia will be ready to join the OPEC meeting to freeze or reduce the production only in the case there is an agreement within the organization itself.

But it seems it is too early to talk about the consensus. Apart from purely economic issues, the consensus is hindered by political differences of participating countries, and especially Saudi Arabia and Iran. On the other hand, both players are committed to a compromise. “Saudi Arabia has demonstrated flexibility and willingness to work under these conditions. Russia has also been working with us for the past few months and agreed to join us as soon as the OPEC is open. But I think that the market will improve, the prices will rise, no matter if we reach an agreement on freezing or not”, said B. Zanganeh to Russian TV channel Russia-24.

“If we reach an agreement, then we will come together with the non-member states and will hold a meeting, likely in November, to conclude the agreement. I hope it will raise rebalance and bring tangible investment in sustainable development at the level of supply that meets the healthy demand that we are seeing now”, added Zanganeh.

OPEC Secretary General Mohammed Barkindo also said about the need to achieve balance, which is expected only by the second half of 2017. According to him, the main issue of balancing is the reduction of oil volumes in storages, which currently reach 3.1 billion barrels, an increase of almost 350 million barrels higher than the normal levels.

At the same time, no matter how hard the major oil-producing countries are trying to achieve the balance, we cannot ignore the growth of shale oil production in the United States. It was the “shale revolution” that has made a significant contribution to the current price crisis on the oil market. The price war launched by Saudi Arabia, gave the results - this year, only the United States will reduce production by 700 thousand bpd. The number of drilling rigs in the shale deposits has decreased from 1,600 at the peak of production in October 2014 to 400. But the lower oil prices could not completely kill the shale oil sector. According to Baker Hughes, the number of drilling rigs in the US is still growing in the past two months. This suggests that the producers have adapted to existing prices of $40-50 and do not intend to reduce the activities.

According to SOCAR President Rovnag Abdullayev, the US shale oil already has a great impact on the price of oil on the world market than OPEC. “The prices depend on supply and demand, involvement of banks in oil trading through the stock markets, and oil shale production in the United States. The price of oil is actually determined on the stock exchange by banks and hedge funds, and varies greatly depending on costs. The cost of the US shale oil will be a determining factor for oil prices in the nearest future”, said R. Abdullayev.

Under current circumstances, any rise in oil prices will lead to an accelerated increase of oil production in the US, which would in no way regulate and limit the level of production.

Anyway, the next year will be even more stressful for the oil sector, and the major manufacturers are cautious in determining oil prices in state and corporate budgets. Thus, according to the Minister of Finance Samir Sharifov, the state budget for 2017 is drafted based on an average price of $40 per barrel. SOCAR is drafting its budget at the same price level. BP does not expect a breakthrough increase in oil prices either. According to Gordon Birrell, President of BP in Azerbaijan, Georgia and Turkey, “the company tries to keep the production level at ACG block at given current oil prices. There oil supply is still dominant over the demand in the market. So, I do not think that oil prices in 2016-2017 will increase significantly”.

But the current decline in prices threatens the global market with oil shortage in the future. According to IEA estimates, the observed drop in investments to the oil industry reached $300 billion, which was the largest drop in 30 years. It is expected that this trend will continue in 2017. First and foremost, the fall concerns investments to the exploration and discovery of new deposits. In the medium term, this will largely affect the oil supply as a whol - the leading producing countries have actually reached the ceiling and do not have reserves to increase production without large investments. Although the experts believe that the oil prices will not return to the level of $100 per barrel in the coming future, the limit of $60 is quite achievable.

In any case, the market is responding sluggishly to any reports about freezing or recovery plans to control oil prices, and pays more attention to concrete actions and physical balance of supply and demand. This means that the market really enters to a state of self-regulation, when individual pieces of information can hardly shake long-term trends and refrains from artificial control options depending on political motives. This factor can be the basis of the future stability in the oil market.