Although OPEC reached a consensus on cutting its oil output and Russia voiced its agreement to join the decision, it remains to be seen whether countries will stick to their pledges.

The OPEC deal sent a good signal to the international energy community, yet numerous thorny issues remain unresolved. Photo: AP

The latest Organization of the Petroleum Exporting Countries (OPEC) deal, finalized by its members and other leading oil producers on Nov. 30, has the potential to alter thoroughly the current anemic state of affairs in the oil sector.

Despite predominantly skeptical prognoses, OPEC managed to coordinate a joint reduction in the members’ oil production, settling on a 1.2 million barrel per day (bpd) cutback from their November output levels, to be implemented in the first half of 2017.

Russia, having decided to support the OPEC production cut initiative and having mediated between Riyadh and Tehran in the lead-up to the Vienna Summit, might turn the agreement to its advantage.

Almost all OPEC members pledged to cut production within the framework of the Vienna Agreements – Saudi Arabia (486,000 bpd), Iraq (210,000 bpd), United Arab Emirates (139,000 bpd), Kuwait (131,000 bpd), Venezuela (95,000 bpd), Angola (80,000 bpd), Algeria (50,000 bpd), Qatar (30,000 bpd), Ecuador (26,000 bpd) and Gabon (9,000 bpd).

Surprisingly to many, Iran was allowed to raise its production to 3.795 million bpd, essentially nullifying Riyadh’s previous attempts to engage Tehran in a joint initiative. Libya, still suffering from a bloody civil war and struggling to defeat the Islamic State of Iraq and the Greater Syria (ISIS) on its territory, and Nigeria, weakened by constant acts of sabotage by the Delta River Avengers, were exempted from the quota mechanism.

More alive than dead?

Following the Vienna deal, OPEC’s global role has been tangibly reinvigorated. Saudi Arabia demonstrated its readiness to compromise on output-related issues. For more than two years, ever since November 2014 when Riyadh walked back from the quota system to retain its global market share, OPEC has found itself paralyzed as the leading OPEC oil producer reneged on its leadership role.

OPEC has abandoned the quota system previously, for instance during the Gulf Crisis of 1990-1991; yet, despite a poor record of fulfilling member obligations, it has stuck to a policy of sending regular signals to the market that at least superficially suggested some form of policy coordination. OPEC’s role was also reinforced by the factual reintegration of Iraq in its quota mechanism, as Baghdad was excluded from it for almost 26 years after its invasion of Kuwait unleashed the Gulf Crisis in 1990.

As OPEC members agreed to suspend Indonesia’s membership, the only country in the organization that was a net oil importer, the oil exporters’ cartel reverted to its initial objective – coordinating the activities of oil-exporting nations. The G-3 group of producers, consisting of Saudi Arabia, Kuwait and the United Arab Emirates, displayed commendable unity in coordinating their cuts by a total of 756,000 bpd.

The aspirations of cash-strapped countries like Venezuela, which needs a crude oil price of at least $120 per barrel to balance its budget, were even taken into consideration, if only incidentally. And most importantly, the OPEC deal demonstrated that by means of prudent moderation the Saudi Arabia – Iran hostilities can be managed in the service of a noble aim. The OPEC deal sent a good signal to the international energy community, yet numerous thorny issues remain unresolved.

Most likely, the production cut will turn out to be a short-term one. Firstly, the production cut was agreed upon for six months, thus, raising the issue of renegotiating the deal for the second half of 2017. Fundamental changes would presuppose long-term commitments and it remains an open-ended question whether OPEC members are willing to take the plunge.

Moreover, countries exempted from the Vienna Agreements could jeopardize the progress that has been made. OPEC’s November 2016 data show that Nigeria and Libya, along with Angola, were among the leading causes of the cartel’s output growth as it reached 34.19 million bpd. As Libya’s National Oil Company intends to raise its 2017 output to 1.1 million barrels per day from the current level of 560,000 barrels per day, effectively doubling it, and Nigeria wants to restore production to 2.2 million bpd (currently 1.7 million bpd), intra-OPEC resentment might also lead to the deal being abandoned.

The case for prudent optimism

As leading oil-exporting countries tried to blaze a trail that would ultimately lead to more attractive market conditions and price levels, Moscow was active and present at all stages of negotiations. Yet after the disappointing failure of the Doha Summit in April, when Saudi Arabia called off an all-ready document arguing that Iran should not be exempted from the joint initiative, it opted for a more circumspective approach. Up to the summit itself, Russia’s Energy Minister Alexander Novak did not touch on the topic of possible Russian concessions to make the deal happen. Yet behind closed doors Moscow was instrumental in reconciling Saudi Arabia with Iran, at least temporarily.

If previous OPEC-Russia coordination is anything to go by, Moscow is very unlikely to abide by the Vienna agreements. In 1998, as OPEC tried to clear through a production cut to regain pre-financial crisis pricing levels, Russia pledged to cut its output by 7 percent, yet ended up increasing it throughout 1999.

In 2001, as the oil market collapsed against the background of 9/11, OPEC once again asked Moscow to take part in a joint production reduction endeavor. Although high-ranking officials from the Kremlin pledged to see the 50,000 bpd cut through, yet again the lowering of output did not materialize. Then minister Alexei Kudrin attributed this failure to the government’s inability to impose the production quota, as most companies simply bypassed the state-owned Transneft system to deliver oil to markets, using other means of transportation, primarily rail.

Russia is no longer the country it used to be 15 years ago, despite the fact that its president remained the same. The premises changed considerably – in 2001, Russian oil companies produced 7 million bpd, whilst currently their output has reached 11.2 million bpd. The nation is facing the prospect of a budget deficit of 3.7 percent in 2016, and 3.16 percent in 2017, the reimbursement of which will be done mostly through using Russia’s Reserve and Stability Funds. A hike in oil prices might preserve Russia’s funds mostly intact as a general price environment of $55 per barrel would result in additional $15 billion of government revenues, largely staving off the risk of a budget deficit. Therefore, Moscow might fulfill its assumed obligations in good faith.

Also read: It's too early to talk about the end of the oil era

Tricks and cheats

Without a doubt, Russia will benefit substantially from the OPEC deal. Russia vowed to decrease its production gradually, therefore decreases are most likely to occur during the second quarter of 2017. Until then, Moscow has a lot of time to monitor the fulfillment of OPEC members’ obligations. These members have pledged to introduce cuts from January.

Moreover, Russia has explicitly stated that its output cut is tied to other countries complying with the Agreement. Notwithstanding the viability of the deal in the second quarter of 2017, Russian oil output is traditionally the lowest in March-June as the thawing of ice and snow, as well as more volatile weather conditions generally, lead to the phenomenon of “rasputitsa” (the season of impassable roads). As transportation to and from numerous oil fields is encumbered, output is lower.

Furthermore, the Energy Ministry might intend to implement an across-the-board cut, yet companies might think otherwise, especially those with greenfield projects coming up in the next few months. Therefore, if it will take place, the output cut will be piecemeal, with marginal low-profitability and mature low-production wells to be among leading candidates to be shut or postponed.

Yet even these cuts will largely depend on the goodwill of oil-producing companies, as they still are still in a position to repeat the events of 2001 – bypass state-controlled supply routes to have the goods delivered. In reality, Moscow has little leverage over private rail transportation or over the utilization of privately owned oil platforms, and even less when it comes to barges.

On Dec. 10, OPEC and non-OPEC members will gather in Vienna to further discuss the technicalities of the production cut, namely the distribution of the required 600,000 bpd among the 14 non-member states. The largest cuts are expected to come from Russia (300,000 bpd) and Mexico (a 150,000 reduction was suggested by OPEC members), with Oman, Kazakhstan and Azerbaijan as other possible candidates.

Out of the multiple states invited, Turkmenistan has refused to participate in the event, while others like Brazil let the OPEC initiative pass without remark. In view of the facts stated above, Moscow is very likely to assume its obligations. The production cut will not hurt that much (in only four months of 2016 did Russia produce more oil compared to the OPEC-coordinated cap of 10.9 million bpd), whilst its benefits are manifold. Even if the deal ultimately falls through, it served a useful purpose of maintaining oil prices at a more palatable level.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.