Saudi Rejects Swing Role As Pressure Piles On OPEC

Saudi Arabia's signal that it would step back from its traditional swing producer role highlights OPEC's response to shifting fundamentals in the global market. Given the tensions in play, the coordinated action Riyadh is seeking will be difficult to organise but may well be necessary. The latest developments pose downside risks to our production forecasts for OPEC members, but could also put pressure on prices over the longer term should countries forgo planned upstream investment.

Reports are emerging that Saudi Arabia has signalled that any necessary curtailment of production by OPEC would have to come in a coordinated move. This marks a significant shift in strategy, given Saudi Arabia has previously moved unilaterally to balance the global market, acting to increase or reduce production in order to maintain supplies while simultaneously trying to protect prices. As OPEC's largest producer and holder of the majority of the organisations reliable spare capacity, markets have long looked to Riyadh to ascertain the state of global supply.

There were reports that as recently as November Saudi Arabia maintained its position that it was willing to act unilaterally regardless of the views of OPEC members. However developments from both within and outside OPEC suggest change is in order and that the shift is already underway. Mohammed Al Mazrouei, energy minister for the UAE, told reports that OPEC would act 'collectively' and that member 'cannot do something unilaterally.'

Saudi Arabia Prepares To Lead...From Behind
OPEC November Production (LHC) And Spare Capacity By Country (RHC) (%)

Saudi Arabia's signal that it would step back from its traditional swing producer role highlights OPEC's response to shifting fundamentals in the global market. Given the tensions in play, the coordinated action Riyadh is seeking will be difficult to organise but may well be necessary. The latest developments pose downside risks to our production forecasts for OPEC members, but could also put pressure on prices over the longer term should countries forgo planned upstream investment.

Reports are emerging that Saudi Arabia has signalled that any necessary curtailment of production by OPEC would have to come in a coordinated move. This marks a significant shift in strategy, given Saudi Arabia has previously moved unilaterally to balance the global market, acting to increase or reduce production in order to maintain supplies while simultaneously trying to protect prices. As OPEC's largest producer and holder of the majority of the organisations reliable spare capacity, markets have long looked to Riyadh to ascertain the state of global supply.

Saudi Arabia Prepares To Lead...From Behind
OPEC November Production (LHC) And Spare Capacity By Country (RHC) (%)

There were reports that as recently as November Saudi Arabia maintained its position that it was willing to act unilaterally regardless of the views of OPEC members. However developments from both within and outside OPEC suggest change is in order and that the shift is already underway. Mohammed Al Mazrouei, energy minister for the UAE, told reports that OPEC would act 'collectively' and that member 'cannot do something unilaterally.'

Supporting the shift in strategy may well be a growing recognition in Riyadh that given the scale of the potential changes underway, acting independently may not be in its best interests or perhaps of OPEC itself. In our view, the key challenges that OPEC must manage are:

  • Rising OPEC Production: Namely from Iraq, which is still outside the production quota system, but is on track for robust expansion of its output. This is already leading to tensions among other producers as they increasingly compete for market share in Asia. Other producers such as the UAE are also investing billions in raising upstream capacity.

  • Potential Return Of Iran: As we have noted previously the removal of sanctions on Iran's oil sector would be a game changer and over time could see Iran return its pre-sanctions production levels approaching 4mn barrels per day (b/d). With Iran claiming to have secured an agreement at the most recent OPEC summit for other members to 'make room' for a return of its crude should restrictions be loosened, the impact on the state of the global market could be dramatic.

Oversupplied...But Will Others Make Way For Iran?
Iran, Iraq & UAE Crude Production
  • Rising Non-OPEC Supplies: Led by North America, production from non-OPEC producers is also set for impressive growth at time when consumption among developed markets is set for only incremental or even negative growth. These factors have only increased the importance of securing market share in fast growing Asia more important to OPEC producers.

Supplies Rise As Demand Stalls
Americas Oil Production (LHS) & Global Oil Consumption % Change y-o-y (RHS)

Threats On All Sides But Iran's Return Looms Largest

Given the scale of these challenges, which may well fundamentally shift the state of the global market, Riyadh may now feel that it is neither fair nor prudent for it alone to act in order to balance supplies. Although the shift could be a bluff to see other members reconsider the reliance on Saudi Arabia, given the evolving realities we still would see increasing risks to Saudi Arabia acting unilaterally regardless.

While disagreements among OPEC members over production and broader geopolitical issues are not new, tensions among members over Iraq, prices, and Iran are rising. The return of Tehran to the centre of OPEC after years of marginalisation due to sanctions is the most vexing issue for OPEC's Middle Eastern members. OPEC Gulf monarchies are waging a battle with Iran for influence in the region, with Sunni-Shi'a tensions at their height. Before OPEC can determine whether or not it can survive the return of Iran economically, it must ensure it can survive politically given recent history.

Thus, Saudi Arabia's decision now to prepare the way for greater coordination and collective action, may be a wise. Forcing the organisation to resolve its political differences now before action is required later. We noted recently that we see it as increasingly likely that OPEC will reduce production at some point in 2014 ( see, No Change Expected For OPEC, But Reduction Likely Next Year,' December 3).

Where Do We Cut? 2014 Reduction In Sight
OPEC Production ('000b/d)

There Will Be Blood

Although we see increasing risks of a production cut by OPEC, we acknowledge the curtailment could come from unilateral move by Saudi Arabia given its history of acting alone ( see, 'Oil Price Outlook - Structural Changes Alter Urals and OPEC Fundamentals,' December 9). With the pressure now for a coordinated effort the issue has become considerably more complex. Although the UAE seemed to signal support for such a move, we see risks that not all OPEC member will be as supportive.

Too Close For Comfort: High Spending Raises Stakes
Fiscal Breakeven Oil Price (US$/bbl)*

OPEC members such as Algeria may be reluctant to cut production given their weak fiscal position relative to wealthier Gulf states flush with currency reserves from the recent high prices. Even those with the financial capacity to weather a production cut, may be reluctant to cede hard fought market share given the increasing competition. Markets such as Iraq and Iran, may equally be resistant to curtail or slow down their own production, citing their right to return to regain their previous status.

However failing to work together would only exacerbate the downside risks to OPEC, as oversupply is expected to increase prices are due to fall, only worsening their own fiscal position. Therefore it may be wise to allow disagreements to be happen now, before a decision is needed, rather than later when almost certain action is necessary.

Upside Risk To Prices As Cuts Play Out

Given these developments are at their early stages, fully assessing the likely outcome and impact remains difficult, but we maintain our view that OPEC is likely to reduce supplies from 2014 and now see it as likely that there will be a push for collective action. The success of this effort is uncertain; although members are likely to be compelled to act given they face a worse alternative should they fail to act altogether. As we await greater clarity on these moves, we note they present clear risks to our forecasts over the short and medium term:

Over the short term, we now see downside risks to our forecasts for OPEC producers. While we have already assumed a slight reduction (of around 1%) in Saudi supplies for 2014 for example, we will be watching these developments play out closely and may revise our figures further downward should events justify.

While the immediate impact of reduced supplies could help to stabilise prices, with markets more confident that surplus production could be readily brought online if needed, the longer term risks could be to the upside. We see risks that over a longer horizon reduced supplies from OPEC could pose upside risk to our price forecasts and to our view for a gradual moderation - although remaining historically elevated - in Brent prices. These risks stem from the potential that in light of lower prices and less demand, OPEC members will forgo planned upstream investment. Over time this would result in reduce spare capacity. This point has been made previously by OPEC Secretary-General HE Abdalla S. El-Badri, who warned of the potential consequences from bullish forecasts of non-OPEC supply growth.

OPEC Cut Could Support Brent
Brent (US$/bbl)

Although OPEC has stated a preference for prices to remain in the US$100-110/bbl range, reducing supplies from the cartel could increase the upward pressure on Brent. Events in North Africa and Nigeria have demonstrated the unreliability of major suppliers, risks we expect to remain well into 2014. We believe that the impact of reduced OPEC supplies could be exacerbated by unplanned supply disruptions thus presenting upside risk to prices at least from a sentiment perspective but potentially to physical supplies as well. Key to gauging the risks will be the extent to which supplies are reduced, a figure which remains difficult to ascertain at present.

Tightening Spare Capacity Likely To Pressure On Prices
OPEC Spare Capacity And Brent Prices

Thus while we maintain our forecasts for lower prices in the coming years, we are watching OPEC's response to changing circumstances with a view toward the impact on our forecasts.

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