Why the Saudis are Playing Games with Their Own Oil Deal

By the time you read this, Marina and I will be above the Atlantic, on our way to Paris.

When we land, I’ll be talking about energy developments with colleagues from the International Energy Agency (IEA). But even before we touch down in the “City of Lights,” things in the oil industry have started changing… fast.

You see, at the end of September, Saudi Arabia successfully brokered the framework for the first OPEC oil deal in years.

But now, the Saudis are suddenly making some very strange moves… Moves that look like they’re meant to undermine the very deal they just negotiated.

Appearances can be deceiving.

Here’s what Saudi Arabia is really doing – and why…

The OPEC Deal is a Work in Progress

During the Algiers International Energy Forum (IEF) ministerial meetings two weeks ago, OPEC had signaled it was ready to move on a production cap. But the cap itself wasn’t announced at the time.

Instead, OPEC indicated that the details would be agreed on by the next regular meeting of the oil cartel, on November 30 at its Secretariat in Vienna.

In other words, as I’ve discussed here in Oil & Energy Investor before, this “Algiers breakthrough” was little more than a placeholder with details to be filled in later.

Now, while the Algiers meetings were still taking place, I predicted that OPEC would have to hold a special meeting with non-cartel producers (especially Russia) before the Vienna meeting at the end of November. Subsequently, the World Energy Congress meeting currently underway in Istanbul becomes that occasion.

When we land in Paris, I’ll be comparing notes with colleagues at the IEA. But our main subject of conversation has already been set for us by Saudi Arabia’s latest surprise move…

Saudi Arabia Has Already Undermined One Oil Deal This Year

For those hoping for an oil production cap deal, Saudi Arabia has been sending out some disturbing signals.

To make things even worse, others are beginning to respond in kind.

But to see why Saudi Arabia’s recent actions are so concerning, we first need to cover some background on how an oil deal is supposed to work.

You see, for a cap to take effect, the countries controlling the bulk of global production need to agree on a monthly oil extraction level. Now, some overproduction will take place. This is especially likely among nations that are on the edge of financial meltdown, and so are desperate for revenue. So any oil cap deal has to cope with some inevitable “cheating” on the margins.

Of course, there’s no way to enforce an oil agreement from the outside. The market itself will constrain a flood of additional production, by lowering prices in response. Instead, self-policing is the only way for the deal to survive.

And that will only happen if the prospect of stabilizing and then rising prices is appealing enough.

OPEC’s target production level is thought to be 32.5 to 33 million barrels a day, roughly the cartel’s actual production levels from January. That’s roughly the daily figure from January.

That, in turn, was supposed to be the cap agreed to at the Doha extraordinary meeting in April. Supposed to, that is, until Saudi Arabia scuttled any chance of that happening at the eleventh hour…

Getting Russia On Board is Crucial for OPEC

That’s when Riyadh suddenly insisted that Iran be included in the accord. Unfortunately, Tehran had not even sent any representatives to Doha, as it had all along insisted that it would not participate in a cap until it reached its oil production levels from before the recently-lifted international sanctions.

This time around, Iran is within a few hundred thousand barrels (at least on paper) of approaching that level – 4.2 million barrels a day. The Iranian leadership is also interested in “stabilizing” oil prices, participated in the sidebar conversation at Algiers, and will be at Istanbul.

As you saw here last week, even if a specific production ceiling can be agreed on, OPEC must wrestle with setting individual production quotas for member countries, and then coordinating that with Russia and others who are not members of the organization.

Now, after coming on board for a production cap in Doha, Russia was upset that Saudi Arabia pulled the rug out at the end of the summit. So it’s not surprising that following the Algiers summit, and the announcement of a framework for a deal, a number of contacts at the Russian Ministry of Energy (Minenergo) are taking a wait-and-see attitude.

Which not only makes the negotiations between now and OPEC’s general meeting on November 30 more difficult…

It also guarantees a response from Saudi Arabia – a response that, as I mentioned above, threatens the whole idea of an OPEC oil production cap…

Saudi Arabia is Fighting for Market Share in Advance of the Deal

You see, for the second time in less than six weeks, Saudi Arabia’s national oil behemoth, Saudi Aramco, has cut the price of its oil shipments to Asia.

This is a transparent attempt to gain additional market share in advance of any cap. But it also depresses the very rise in crude prices that all oil producers are looking for.

And as you’ve seen me discuss here in Oil & Energy Investor before, a Saudi cut in prices to Asia has one objective – to take market share from Russia in what is becoming the main oil market battleground moving forward.

Russia has already responded by ramping up its own production well beyond sustainable levels while likewise cutting prices.

Over the weekend, OPEC member Iraq entered the battle by pledging to increase its own production in response to the Saudi and Russian moves.

In short, Riyadh has initiated another round of a price war that every producer will lose – a price war that is counterproductive to the deal that the Saudis themselves both brokered and announced in Algiers.

But if it works, it could lock in a larger part of the highly lucrative Asian oil market for Saudi Arabia.

I expect some heated and interesting discussions in Paris. You’ll be the first to hear any developments, right here in Oil & Energy Investor.

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