The Long-Term Significance of OPEC’s Production Cuts
Anwar Altaqi – Esam Aziz
Before the end of 2018, OPEC might end its production cut arrangement. Whatever decision the organization makes, the deal, and the high level of adherence by all members, will remain a unique lesson in the recent history of oil markets.
While we sense objective pressures building on OPEC — mainly due to three years of record high prices — to review the deal, we think that even when the deal ends, its consequences will remain for a long time to come, particularly in the Gulf Cooperation Council (GCC) countries.
For those countries, working with non-OPEC producers may become a turning point in their global outlook, and, hence, their international relations. The deal proved that the GCC could work with Russia and other major producers to foster mutual interests. It weakened the traditional understanding that alliances imply identical, shared policies and that coordination with old friends is essential to the international relations of Arab states.
Most analysts who study and comment on geostrategic affairs focus mainly on changes in the global balance of power between major international players. However, if this balance of power is translated into concrete and objective changes on the ground, it would take a different shape. That is to say that other countries in the world play an increasing role in defining the global balance of power when they construct their foreign policies.
In this case, it all started with oil, when a global glut was worsened by a dramatic increase in US production. This came after almost two decades of costly mistakes and misinformed approaches from two consecutive US administrations under George W. Bush and Barack Obama.
Such conditions prompted GCC capitals to undertake a profound review of their foreign policies.
The production cut deal only boosted a more realistic and less ideological approach to foreign policy. The message of OPEC producers, particularly in the GCC, was simple: We will follow our own interests, even when it makes us adversaries of our old friends.
GCC countries are considering extending their outreach to non-traditional partners even further. Just a few days ago, the United Arab Emirates’ (UAE) oil minister hinted that an alliance between OPEC and non-OPEC producers, including Russia, could continue in some shape or form. Energy and Industry Minister Suhail al-Mazrouei said the partnership between global oil producers to try to stabilize oil markets, by curbing output, was working.
Saudi Oil Minister Khalid al-Falih then confirmed what appears to be a GCC consensus in terms of orientation. Al Falih said that OPEC and non-OPEC oil producers have a consensus that they should continue cooperating on production after the end of 2018, when their current agreement on production cuts expires.
Soon after, Russian Oil Minister Alexander Novak announced that his country welcomes this step. “The world’s two biggest oil producing and exporting countries can continue their cooperation for the good of the crude industry, for the good of stability,” Novak said in Muscat, Oman. Novak’s response contrasts with the viewpoint of principle oil executives in Russia. “If the price of $70 remains for more than half a year, we should start exiting smoothly,” Lukoil Chief Executive Vagit Alekperov said recently.
What is significant in this picture is that Russia, which some Arab countries view as “suspicious,” to put it mildly, was immediately receptive to the idea of cutting its oil production, while the United States, allied with many regional forces, was busy committing one mistake after another in the region. US producers continued increasing their production, even when they were losing money, thanks to the assistance of the financial system and governmental tax breaks.
Furthermore, even during the production cuts, Russia’s oil industry continued its longterm expansion in 2017, with production hitting a record high, even as President Vladimir Putin joined forces with OPEC to clear a global glut and lift prices. Russia’s oil output increased to an average 10.98 million barrels a day in 2017, up 0.1 percent from the previous year, according to data published by the Russian Energy Ministry’s statistics unit. That is the ninth consecutive annual increase to the highest level since the collapse of the Soviet Union in 1991.
Yet, the impact of the oil deal on the GCC geostrategic outlook cannot be clearer. With the success of the deal, there is now a possibility of extending it to other areas.
True, the deal was not the single factor behind price improvement. Global demand increased and forecasts have it increasing even more. It is ironic that the main risk to this improvement, which helps the GCC nations balance their budgets, comes from their traditional ally (the United States), while the main helper is none other than their previous adversary (Russia).
However, the United States seems more aware now that increasing production for the sake of increasing is a foolish policy. As we have repeatedly argued, shale producers hurt themselves, as well as other producers, if they continue to disregard the market glut and the impact of their extra production on prices.
There is one more risk that may threaten GCC-Russian cooperation in production cuts: the very success of this cooperation itself. An expert working for Goldman Sachs, Jeff Currie, got it right when he said, “Getting prices too far above $70 can both stimulate new supply and affect the economy. OPEC members do not want to see that.”
There is an unintended consequence of higher prices. OPEC and non-OPEC producers are watching not only the shale sector’s response to higher prices, but also the rising potential of deep water and of oil sands from Canada.
Prices will go wherever the market dictates. But what will remain is the lesson of the production cuts’ deal and its geostrategic significance.