The ‘freeze’ that failed to warm sentiment in the oil market


In more “normal” times the oil market might have analysed the implications of a highly conditional “output freeze” agreement between a handful of producers amid a persistent supply glut, before reacting. But these are not normal times. The deal—that actually wasn’t—ended up whiplashing the already panicky market and leaving it hopelessly hopeful.

Brent crude had clambered above $35 as February drew to a close, with NYMEX light sweet futures around $33/barrel, both 25% above the year’s lows touched on 20 January, though nothing had visibly changed on fundamentals.

What had changed was a lot of jawboning by a few oil ministers upending earlier convictions that an Organization of the Petroleum Exporting Countries (Opec)/non-Opec collaboration to rein in supply was out of the question. By the end of the month, the can had been kicked down the road, to a mid-March meeting between major producers flagged by Russian energy minister Alexander Novak.

The fact that crude oil prices have more than halved since Opec’s landmark decision in November 2014 to defend market share at any cost, leaving producer pockets across the globe in tatters and equilibrium seem increasingly like a mirage, lent credence to the deal between Saudi Arabia, Russia, Venezuela and Qatar at a meeting in Doha on 16 February.

Only, it was so conditional—other major Opec and non-Opec producers have to join in for the agreement to take effect—and so watered down—capping output at January levels rather than actually cutting it—that it was hard to take it seriously.

Bijan Zanganeh, oil minister of Iran, which is aspiring to boost exports by 1 million barrels per day (mbpd) over the coming months, dismissed it as a “joke” in remarks published by the country’s ISNA news agency on 23 February—barely a week after hosting his counterparts from Iraq, Qatar and Venezuela and expressing support for the freeze proposal.

Russia’s Novak, who has been driving the collaboration initiative, suggested a freeze could take effect even without Iran’s participation. Major producers outside Opec expected to be roped in include Mexico and Norway.

A freeze at January levels could remove 1.3 mbpd of oversupply from the markets, Novak said, though he didn’t explain the math behind the number. Some deduced that it might mean an absence of the typical seasonal ramp-up in Saudi crude oil production of up to 750,000 bpd to meet increased demand from power production at home during summer months. But that would leave the kingdom bearing the brunt of the cutback, something hard to fathom, especially without political arch-rival Iran chipping in.

Opec’s second largest producer Iraq, which hit a new high of 4.33 mbpd in January, remained conspicuously silent on its plans. Opec’s 13 members pumped 32.43 mbpd in January, about 820,000 bpd above the 31.61 mbpd average 2016 demand for its crude the organization projected in its February report. Saudi oil minister Ali al-Naimi, addressing an industry conference in Houston in the week of 22 February, expressed confidence that major producers, including Iran, would join the freeze pact, but said seeking production cuts would be “wasting our time” as no one would deliver.

Some analysts concluded that Saudi Arabia might simply be testing its fellow producers’ willingness to cooperate and comply with a relatively benign freeze commitment (other than for Iran) before proposing a production cut at Opec’s June meeting.

Indeed, as the month progressed, the freeze plan appeared all entangled with suggestions of a production cutback.

Non-Opec Oman, for its part, offered to cut output by 10%, or 100,000 bpd, if a deal was reached between major Opec and non-Opec producers.

Paris-based International Energy Agency, policy adviser to the world’s developed countries, cautioned those forecasting a price recovery in the short term of a “possible false dawn,” citing resilient US shale output, rising stocks, and little apparent chance of coordinated Opec/non-Opec production cuts.

Christopher Bake, member of the executive committee at global energy and commodity trading company Vitol, said at the annual International Petroleum Week in London that the world could put another 360 million barrels in commercial crude oil and refined product stocks over the next six months unless supply and demand rebalance, having added 450 million barrels through 2015.

US shale’s resilience, though, is on test. Bankruptcies and ratings downgrades are on the rise, with the spring round of bank loan redeterminations expected to see a 20-30% reduction in the borrowing bases of the small and mid-sized producers, who are also fast losing hedging protection due to a depressed forward curve.

US shale doesn’t need $90 per barrel anymore, Dave Hager, CEO of Devon Energy, told IHS CERAWeek in Houston, but $55-60 is where the “vast majority” of plays would work. For shale production to actually grow, the industry needs a $60-70 per barrel price, Scott Sheffield, CEO of Dallas-based Pioneer Natural Resources, said at the same event.

That suggests there could be a “sweet spot”, around $50-55 per barrel, at which conventional and unconventional oil supply balances with global demand. It keeps the most efficient shale oil in business while curtailing the production boom of the past few years; gives some breathing room to the big producing nations while maintaining the pressure on them for greater fiscal discipline and economic diversification; and satiates the growing appetite of the major import-dependent emerging economies while providing them the much-needed relief of reduced forex outflows.