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What Happens If The OPEC Deal Fails?

Tuesday, October 4, 2016 3:49
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(Before It's News)

Oil derrickAnalyst Zainab Calcuttawala explores the potential scenarios that could take shape if the proposed OPEC production cap doesn’t succeed.

Oil prices jumped six percent last week when news broke that members of the Organization of Petroleum Exporting Countries (OPEC) had agreed on the rough outline of a freeze deal in Algiers.

The deal would limit the 14-member bloc’s output to between 32.5 million barrels-per-day and 33 million barrels per day, but for it to be implemented, members need to agree on who will be cutting, who will be maintaining, and who will be allowed to ramp up production – a paradigm that remains unmet as of today.

Oil Price’s Nick Cunningham wrote last week about the weak and ambiguous nature of the deal currently on the OPEC table: the difficulty in actually agreeing on the details of the reduction, rising oil production within OPEC that could offset the already small cut, and the small size of the planned cut itself (200,000 to 700,000 barrels per day). Add to that the fact that the details will likely not be hashed out until November. And when we say November, we’re talking 30 November. And in the meantime, and very likely until that 30 November date, OPEC will continue to produce at record levels.

Russia said they would be onboard with the deal—meagre as it may be—so long as OPEC manages to reach an agreement internally—but this too has a rather unimpressive ring to it, what with Russia ramping up production to highs of 11.11 million barrels as of September.

As lackluster as the news of the price freeze is in reality, it’s moving markets today (or last week, anyway). But what happens in November if the effort fails?

Oil Prices Take a Nosedive

The jump in prices – which has kept Brent barrels above $50 for the past five days – will be short-lived if, in the two months leading up to the 30 November conference in Vienna, OPEC members start getting cold feet.

Iraqi Oil Minister Jabar al-Luaibi has already threatened to abandon the deal, citing concerns with how the production figures are tabulated.

“These figures do not represent our actual production,” he told reporters two days after news of the deal broke.

If by November estimates do not change, “then we say we cannot accept this, and we will ask for alternatives”.

Luaibi even asked a reporter from Argus Media – whose data OPEC uses among other sources to compile estimates of countries’ production – to disclose the sources Argus uses for its market analysis.

“Your sources are not acceptable. And if there is deviation from the government, then Argus will not work in Iraq,” Luaibi told the reporter.

That said, there is little evidence to believe that a price drop stemming from OPEC’s failure to follow through with its plans would be lower than the one seen after the failed Doha talks in April. After Saudi Arabia backed out of the agreement at the last moment, prices dropped by six percent to just over $40.

Venezuela’s Political System Could Fall Apart

Exactly one month ago, one million Venezuelans marched in Caracas against President Nicolas Maduro due to the economic and humanitarian crisis unfolding in the South American country.

In August, Venezuela and Colombia opened their pedestrian border crossings after Maduro ordered them shut last year over smuggling concerns.

Venezuelans flocked to Colombia by the thousands to buy basic supplies – toilet paper, life-saving medications and more – that their government could no longer afford to import. The budget shortfall was caused by low oil prices, but also by massive debts the country owed to China and other entities that needed to be serviced, despite the macroeconomic crunch.

Though fellow OPEC-member Algeria also faces acute budget shortfalls, Venezuela’s political crisis has been brewing into a popular uprising in a more severe manner, and without oil money to ease the suffering, the situation could easily escalate to unmanageable proportions.

Maduro’s opposition forces have been working on a strategy to move up the vote on the president’s recall to the final quarter of 2016, rather than the first quarter of 2017, and if Maduro is recalled before 10 January, constitutional rules mandate a new election. But the National Electoral Council said last month the vote would have to be delayed until the middle of the first quarter of 2017, meaning the president’s recall would put his vice-president in charge until elections scheduled at the end of 2018.

The anti-Maduro fire would rage on if the preliminary agreement does not see the light of day.

OPEC Loses Credibility

If this proposal fails, it will be OPEC’s third meeting this year – informal or not -without a deal: Doha, Vienna, and Algiers.

Before the current oil price crisis began in 2014, OPEC had consistently fulfilled its responsibility of controlling market oversupply. The bloc’s members control just over 40 percent of the world’s oil, meaning a cut enforced by the industry group would produce a larger effect than any other single country on its own.

However, as the financial access of the Gulf states led by Saudi Arabia allow them to pursue goals other than the stabilization of the oil markets, the group will not be able to maintain the credibility of the united front it presented to the world in decades past.

Oil-dependent states – notably, Nigeria, Venezuela, Algeria, Iraq and Libya – require oil markets to recover in order to import consumer goods and pay off international debts, but its financially-savvy Gulf counterparts can maneuver bearish markets to produce politically beneficial results over the long-term.

This could be the final chance for Saudi Arabia, the de facto leader of OPEC, to convince the world that it cares about the future of the union. If not, the KSA will cause irreparable damage to the group’s credibility.

Market Competition Continues at Lower Prices

Iran, Nigeria and Libya will be exempt from the deal, meaning the trio would probably ramp up production whether or not the agreement becomes binding.

Though their actions may not vary because of the deal, their profits will. A production cut from the other members will cause prices to jump upwards, meaning the three countries would be subject to lower competition from Saudi Arabia and Russia and benefit from higher prices.

In the opposite scenario, the recovering countries would feel the heat of competition from each other and from oil giants Saudi Arabia and Russia, and barrel prices would have nowhere to go but down.

Meanwhile, production in the U.S. isn’t fairing too poorly, despite having about half the rigs in operation that it did this time last year. If OPEC fails to curb global supply on its end, we suspect that an extension of the lower for longer price environment would claim a few more U.S. casualties, but the survivors would, out of necessity (which we have on good authority is the mother of all invention), be able to reap profits quite nicely at under $50.

The United States Oil Fund LP ETF (NYSE:USO) fell $0.03 (-0.27%) to $11.07 per share in premarket trading Tuesday. Year-to-date, the largest fund tied to the price of WTI crude oil has gained 0.91%.

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