There was an elephant in the room during the recent OPEC+ meeting: the record-breaking initial public offering of Saudi Arabia’s mammoth oil company Saudi Aramco occurring at exactly the same time.
The coincidence meant that the output cuts agreed by OPEC and its allies were designed as much to bolster the share price of Saudi Arabian Oil Co., as they were to balance the oil market going into 2020. This will greatly complicate matters for Saudi Arabia when it finds itself having to impose discipline on fellow producers looking for ways to adhere to their targets without actually cutting production.
The deal is much weaker than it looks.
The headlines out of Vienna took markets by surprise. The group cut their collective output target by a further 500,000 barrels a day for the first quarter of 2020, taking the reduction from 2018 baselines to 1.7 million barrels a day. Saudi Arabia, the kingmaker in all oil matters, said it would reduce its own target by a further 400,000 barrels a day on top of that — as long as all the other participants adhered to their pledges.
That appeared to indicate that OPEC+ output would be slashed by a very substantial 900,000 barrels a day, with 770,000 of them coming from OPEC and the rest from its partners. But in reality, the difference the agreement will make to physical production is really quite small, even if everyone sticks to their new goals.
Saudi Arabia’s new voluntary target of 9.744 million barrels a day is just 5,000 barrels a day below what it pumped on average over the past nine months, according to the production numbers it supplies to OPEC. That’s no cut at all. In fact, by tying the 400,000 barrels a day to full compliance by everybody else, its offer was actually a thinly-disguised threat that the kingdom would increase output if any of the other countries fail to meet their commitment.
Angola’s production will also go up rather than down in the coming months. The West African country has no new projects to offset steep decline rates at its deep-water fields after the 2014 price crash killed off foreign investment in its oil sector. In November, it pumped about 200,000 barrels a day below its target. Oil Minister Diamantino Azevedo has no realistic prospect of boosting his country’s output to its target level, but should be able to restore about half of its shortfall now that maintenance has ended at key fields.
So even if everybody else does what they have promised, the real cut in output from November levels will be closer to 385,000 barrels a day. And even that is optimistic.
The group’s biggest problems are Iraq and Nigeria. Iraq must contribute almost half of the outstanding OPEC cut, but has failed to get anywhere close to its 2019 target so far. For seven out of 11 months this year the group’s second-largest producer has actually been pumping above its baseline — rather than below — for cuts as spelled out in the agreement. Things have at least been moving in the right direction in recent months, but Iraq remains the group’s biggest over-producer. If anti-government protests spread to oil fields, civil unrest may do what government action has so far failed to deliver.
Nigeria is trying to reclassify some of its output as condensate — a light form of crude extracted from gas fields. Because OPEC doesn’t regulate such production, the change would allow the biggest oil producer in Africa to comply with the new goals without actually cutting production at all.
At the Vienna meeting, Russia, the key non-OPEC contributor to the cuts, secured such an exemption, allowing it to deliver another 40,000 barrels a day of cuts without actually removing a single additional barrel. Other OPEC+ producers with significant condensate volumes — Kazakhstan, Azerbaijan, Oman and Malaysia — may seek similar treatment.
We could easily end up with a deal that is met on paper with very little new oil taken off the market.
Will Saudi Arabia follow through with its threat to open the taps if the rest don’t step up? This game of chicken is a high-stakes one. With many in the OPEC+ group already pumping close to capacity, a Saudi output boost might not start a production free-for-all, but it would certainly undermine oil prices. And that wouldn’t help the share price of just-listed Saudi Aramco.
Foreign investors balked at a $2 trillion valuation for the company, leaving the IPO a decidedly local affair. The valuation of Aramco was at the heart of Saudi thinking at the OPEC and OPEC+ meetings, according to one delegate who was in the closed-door sessions. And that fixation will continue as the kingdom seeks to maintain the company’s stock price.
The $2 trillion valuation was reached, briefly, on the second day of trading in the stock. How it will fare over the long term is a different matter, and may be even harder to control than OPEC+. Saudi Aramco may be forced to keep cutting its own output to bolster the share price whatever the rest of the producer group does.
© 2019 Bloomberg L.P.