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Sophia Kortunova

International College of Economics and Finance, Higher School of Economics

The tentative agreement among oil exporting countries to freeze oil production rekindled the practically extinguished hopes for a turn of the bearish trend and an increase in the price of black gold. The next meeting to discuss the issue is to take place between March 20 and April 1, 2016. More than 15 countries have joined the agreement so far, including Russia, Saudi Arabia, Nigeria, Qatar and Venezuela. Some big American companies are also planning to cut production.

The tentative agreement among oil exporting countries to freeze oil production rekindled the practically extinguished hopes for a turn of the bearish trend and an increase in the price of black gold. The next meeting to discuss the issue is to take place between March 20 and April 1, 2016. More than 15 countries have joined the agreement so far, including Russia, Saudi Arabia, Nigeria, Qatar and Venezuela. Some big American companies, including such giants as EOG Resources, Continental Resources Devon, Energy and Marathon Oil are also planning to cut production. Even without Iran, Iraq, Brazil and Mexico, whose positions on the issue are still unclear, that already makes up 73% of all oil producers on the market. If the agreement comes into force, it has every chance of reversing the situation in the oil market. However, there are several signs that it is too early to expect a substantial price rise.

First, it has to be noted that on January 11, 2016 (production is expected to be frozen at the level reached during this period), production hit an all-time high: Russia was producing 10.9 million barrels a day; Saudi Arabia 10.091 million barrels; and OPEC 32.3 million barrels, far in excess of its quota. So, even if the agreement comes into force, no serious price growth should be expected, and there will still be an oil glut in the market.

Even if the agreement comes into force, no serious price growth should be expected, and there will still be an oil glut in the market.

Second, Iran’s refusal to join the initiative makes it much less likely that oil producing countries will reach agreement. It is doubtful that even special terms may induce the country to change its mind: Iran’s official representatives described the freeze on oil production as an illogical step for the country and confirmed that, right now, it is important to “not reduce its market share”. After the lifting of sanctions, the country has not yet reached the planned level of oil production and is only “picking up speed”. Thus, stopping production growth at the January 11 level would mean substantial concessions to the detriment of Iran’s own interests, unlike Russia and Saudi Arabia, for which the agreement hardly makes any difference. In this case, Iran may become a bone of contention on which oil exporters would never agree. Without the country that became the seventh biggest oil producer in 2015, the agreement loses much of its effectiveness, as production cuts would instantly be offset by growing supply from Iran.

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Stopping production growth at the January 11 level would mean substantial concessions to the detriment of Iran’s own interests.

Third, the United States – a major player in the market – has yet to join the agreement. At the moment, several big companies are planning to cut production, but this does not mean that they are thinking of cutting production in order to restore and stabilize world prices. The move, if it is made, would reflect the need to cut costs and improve financial performance, which has turned out to be worse than expected. It should also be added that one of the main methods of cutting costs is to only drilling high-return wells while putting on hold extraction at less profitable fields. A large stock of operable wells that are ready to be drilled is thus formed. This means that the United States can increase its oil production at short notice.

We should also remember that the oil industry in the country consists of a large number of small private companies, with which it is impossible to agree on production volumes. Some analysts are predicting a spate of bankruptcies caused by a prolonged bearish trend, which would push small and less profitable producers out of the market. Even so, in the four years since it began, the shale revolution in the United States has proved to be stable against oil price volatility. As soon as they grow big enough, small companies will rush back into business to increase production levels.

The United States – a major player in the market – has yet to join the agreement.

Compounding the situation are the massive accumulated oil reserves: according to the International Energy Agency (IEA), in the last quarter of last year alone oil reserves increased at a rate of 1.8 million barrels per day. Thus, any attempts of the oil exporting countries to agree on production cuts will boost prices, which in turn will create the temptation to sell off the accumulated reserves at a more attractive price. This will further cut prices and stoke up the rivalry between the countries that seek to keep their market share.

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It is likely that the exporting countries may agree to freeze production levels the forthcoming meeting, even without Iran joining the agreement. The issue hinged on the support of the two leading world producers (in 2015) – Russia and Saudi Arabia. The agreement does not make much difference to them: in January 2016, both countries reached record levels of oil production. We will most likely see great price volatility on the oil market in the near future: the market will be “torn to pieces.” News leaked to the press about a possible production cut by oil exporting countries will heat the market, pushing oil prices up. This in turn will cause small American companies to go back into business, increasing the number of drilling rigs in operation and the sale of accumulated stocks. Prices will again plummet, which will create tensions and complicate talks on production cuts. No significant cuts of black gold production should be expected any time soon.

Any attempts of the oil exporting countries to agree on production cuts will boost prices, which in turn will create the temptation to sell off the accumulated reserves.

Nevertheless, it should be noted that the very fact that oil exporters feel they need to coordinate their actions and freeze production, and the large number of producers who have hastened to join the initiative, marks an important step towards solving the problem of the market glut. As the accumulated stocks diminish and production falls (due to shrinking investments in long-term projects), rivalry for market share will become less acute. Eventually, countries will manage to coordinate their actions and put oil prices on an upward trend, but clearly an early change for the better is not on the cards.

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