The last time OPEC splintered, and the Saudi energy minister demonstrated that when it comes to the “cartel”, the only opinion that matters was that of, well, Saudi Arabia, was on November 27, 2014, when in the infamous “OPEC Thanksgiving Massacre”, OPEC effectively broke up after Saudi Arabia decided it could put shale out of business by sending the price of oil so lower, it would cause mass shale defaults and regain market share.
The result was two-fold: oil prices crashed (both immediately as shown below) and over the longer-term, while the Saudi strategy proved to be an epic disaster as it woefully miscalculated that shale’s breakeven price was far lower than the Saudi advisors (Goldman and Citi, as well as a handful of hedge funds) had estimated.
As a result, two years later, OPEC reconstituted itself when in late 2016, it agreed to cut output by 1.5mmb/d.
That strategy worked better, as the price of Brent rose from $30 to as high as $80 over the next 18 month, in fact rising too far, as first concerns about demand destruction emerged, followed by Trump directly attacking OPEC (and by implication his close “friends” in Riyadh) on Twitter, demanding lower oil prices (and thus more oil production) or else risk watching his entire fiscal stimulus crash and burn as a result of soaring gas prices.
We bring this bit of not so ancient history because tomorrow OPEC may break apart again, for the simple reason that Iran, OPEC’s third largest producer, finds itself in a lose-lose situation, in which it either agrees with a production boost, thereby effectively greenlighting US sanctions against itself and allows Saudi Arabia to take over much of its market share, or defies Saudi Arabia, and along with Venezuela, causes OPEC to splinter again.
Sure enough, with just hours to go until tomorrow’s meeting, Iran has continued to reject any increase in OPEC oil production, potentially dooming any effort by Saudi Arabia and Russia to get a consensus decision tomorrow.
According to Bloomberg, during today’s Vienna talk, ministers from some of the world’s largest oil producers failed to secure the sought-after compromise that would allow the cartel to ease back on its production cuts.
And here is where it gets interesting: while Iran alone can veto any change to the group’s output policy, there is historical precedent for the Saudis to act alone and increase supply when they see an urgent need. And even though Saudi Arabia also finds itself between a rock (the Aramco IPO which desperately needs even higher oil prices) and a hard case (President Trump who demands higher oil prices), Crown Prince MbS will have no choice but to yield to the latter, and overrule the Iran veto, concluding the process in which Trump effectively splinters OPEC.
Sensing what is about to happen, Iran – which again has virtually no upside tomorrow no matter what the OPEC decision is – was not happy:
“It wasn’t a good meeting. It was just ceremonial statements“ Iran’s Oil Minister Bijan Namdar Zanganeh told reporters after walking out of the meeting of the Joint Ministerial Monitoring Committee. “There were proposals but I don’t think we can reach an agreement.”
Well, an agreement can be reached. It just won’t include Iran.
So what is the most likely outcome should Iran veto the production boost, and Saudi Arabia overrules it?
Well, as Bloomberg explains, there is still a small chance that Iran will comply; if the Saudi position were to prevail, it would allow the cartel and its allies to partially offset the impact of the collapse in Venezuela’s oil industry and feed fast-growing demand, mostly out of China.
On the other hand, failure would leave the Saudis and Russia with the choice of acting alone to increase production – breaching the historic agreement that ended a three-year oil slump – or do nothing a risk surging prices and supply shortages in the second half of the year.
The most likely outcome is the former, as the Saudi energy minister Al-Falih noted earlier: “our costumers have spoken loudly and we must listen to them,” in reality referencing just one “customer”: Donald J. Trump. He also warned his fellow oil producers about rising consumer anxiety and the potential for high prices to have a negative impact on demand.
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Iran’s veto a non-factor, the next question is what shape the production boost will take. And here, it appears that as we previewed yesterday, the most likely outcome is an output boost of 1+ million b/d.
Quoting an OPEC delegated, Bloomberg said that energy ministers were focusing on the following scenarios, adjusting the group’s daily quota higher by 1 million, 1.5 million or 1.8 million barrels, the person said.
Still, any of those proposals would result in a smaller volume of oil flowing to the market than the headline number suggests because several countries are unable to increase output. For example, the 1 million barrel-a-day increase would translate to just 600,000 barrels a day of crude flowing back on to the market, according to Bloomberg calculations based on data from the International Energy Agency.
The only route to a production boost that Iran has publicly suggested — allowing the handful of countries that have voluntarily cut deeper than necessary to restore some output — would deliver far less extra oil to the market than any of those proposals.
If, however, the Saudi and Russian position prevails and OPEC manages to boost real output by over 1 million bpd, watch the price of oil.
And incidentally, if indeed the oil cartel is about to splinter again for the second time in four years, it is most likely that oil prices will tumble, if what happened in Nov. 2014 is any indication. Sure enough, oil fell after Iran’s walkout earlier today. Should OPEC dissolve itself again tomorrow, watch for a far greater drop in the coming days.