We’ve seen this movie before: in response to low oil prices, a few producers propose a production freeze designed to talk up crude prices but has no real impact on fundamentals.
According to recent press reports, Venezuela, Kuwait and Ecuador are again pushing a production freeze in response to the recent dip in oil prices. Since OPEC meets informally at the upcoming International Energy Forum (IEF) in Algeria on September 26-28, some market participants believe the Production Freeze 2 has real legs pushing prices higher on Monday.
However, we believe the sequel to the production freeze will end the same with no agreement in September. We remain highly skeptical that any meaningful agreement will be reached or that it changes the outlook for oil markets.
First, the production freeze is not a serious proposal but designed only as a public relations tool to effect sentiment and try to establish an artificial price floor. The first freeze proposal was unveiled by Venezuela on February 11 when oil prices were sub-$30. Since that time, the freeze has been talked up by various OPEC members and Russia resulting in a subsequent price bounce. The invitation letter to OPEC members for the April freeze meeting specifically acknowledged that the freeze proposal “has changed the sentiment of the oil market” and “has put a floor under the oil price.”
The same script is being used again after prices dipped into bearish territory in July. But the freeze proposal is again not serious because OPEC is producing at record levels. Ironically, OPEC’s record July production of 33.41 million barrels a day is a major contributing factor in the current weakness in crude prices.
Second, Saudi Arabia and Iran will not agree to a production freeze because the September timing is too soon.
For Saudi Arabia, it's still too soon to take any action now that would raise prices and throw a lifeline to US shale and other non-OPEC producers. In the Saudi view, continued low prices this year are needed to displace non-OPEC production and bring the market into balance. That means continued cap-ex cuts, delayed mega-projects and further declines in non-OPEC production throughout all of 2016. The Saudi’s may once again publicly express a willingness to consider a freeze if other producers, specifically Iran, also agree but we believe that is highly unlikely.
For Iran, the freeze is too soon because it is just eight months into regaining its’ market share after the lifting of nuclear sanctions. Iranian crude exports are now about 900,000 barrels a day, and a key official at the National Iranian Oil Company said that Iran has regained about 80 percent of its market share before sanctions were imposed. Iran is still aggressively pursuing production targets, and therefore, we think it will not and cannot agree to any premature limits.
Finally, with OPEC members Libya and Nigeria struggling to re-establish higher production levels after disruptions and outages, we believe a production freeze will face its own challenges in gaining support and momentum with second tier OPEC members over the coming weeks.
After leading the charge for a freeze in April, Russia’s energy minister on Monday sought to downplay the need for a production freeze saying “prices are still at a more or less normal level.” But the Russian minister said he was open to negotiations. We believe Russia will once again be a strong proponent of a freeze and will time its support to boost sentiment ahead of the September IEF meeting.