25 November 2016, London — OPEC officials are struggling to reach a final agreement on how to share out production cuts implied by the preliminary output accord agreed by ministers in September.
In theory, all OPEC members would benefit in absolute terms if an output cut produced even a modest and sustained rise in oil prices, so there are strong financial incentives for a deal.
But all members are acutely aware an agreement is about more than just a short-term boost to export earnings and has implications for the future regional power structure in the Gulf, which makes a deal harder.
Saudi Arabia will not accept any diminution of its dominant role as the world’s largest oil exporter and the major financial power in the Gulf region. By contrast, Iran and Iraq do not want to cement Saudi hegemony.
The political implications for the regional power structure caused the last attempt to negotiate a production deal to fall apart in Doha in April when it was vetoed by the Saudi royal court, and could yet do so again.
Output And Power
OPEC members need to find cuts totaling at least 640,000 barrels per day (b/d) and perhaps as much as 1.14 million b/d to bring production back into line with the target of 32.5 to 33.0 million b/d.
Saudi Arabia has indicated a willingness to curb its production provided cuts are shared equitably among the organisation’s members and the agreement is transparent, credible and verifiable.
Saudi officials have indicated any agreement can provide some flexibility for Libya and Nigeria, both of which have been hit by supply interruptions which officials characterise as temporary.
But Iran, which claims its output is still recovering from the imposition of secondary sanctions by the United States between 2011 and 2015, has a more ambiguous claim to flexibility.
And Saudi officials have made clear that all members of OPEC must share in the burden of production cuts, including Iraq.
In theory, the negotiations turn on mundane issues including claims for exemptions and the use of members’ own production data versus estimates from “secondary sources” to establish baselines from which to cut.
In reality, the negotiations are about the profound issue of sharing out oil revenues and diplomatic, military and economic power, which is what makes progress so difficult.
OPEC members are reportedly trying to reach agreement on a deal lasting for just six months, but the production allocations are likely to be cited as a baseline for future deals.
Production allocations reached now risk become embedded in future agreements, which is why Iran and Iraq are resisting attempts to bind their output at low levels, or even at all.
Saudi Arabia and the United Arab Emirates are both currently producing record volumes of oil and their share of total OPEC output is relatively high in historical terms.
Both are status quo powers and want any production freeze or cuts to be calculated from a current production baseline.
By contrast, Iran’s production remains well below the peak achieved before the revolution, war with Iraq and U.S. sanctions took their toll, and the country’s share of OPEC output is relatively low.
Iraq’s production is currently at an all-time high, but like Iran, its share of total OPEC output remains relatively low by historical standards.
Iran and Iraq are disruptive powers intent on challenging the status quo, with less interest in an agreement that entrenches current production baselines and restricts their ambitions to grow future oil output.
The political implications explain why any deal can only be agreed at ministerial level at the end of November; the issues cannot be resolved by officials alone during the technical talks currently underway.
But any eventual deal on production allocations will only be possible if it has political backing, at least implicitly, from top political leaders in Riyadh, Tehran and Baghdad.
Experienced negotiators understand that the initial baseline from which discussions proceed has enormous implications for the outcome.
The party that succeeds in establishing the baseline is likely to achieve the most important gains from the negotiations.
Saudi Arabia and the UAE, therefore, tend to focus on recent production and export levels from the 1990s and 2000s when talking about output allocations.
But Iran and Iraq have both experienced a significant disruption of their oil production and exports during the last 30 years as a result of unrest, war and sanctions.
Iran tends to focus on production levels and market share from much further back in the 1960s and 1970s to support its claim for a higher allocation.
The contrasting fortunes of the major Gulf states over the last 50 years explain why agreeing on a baseline for allocations is so difficult.
In 1965, Saudi Arabia’s crude and liquids production stood at around 2.2 million b/d, slightly ahead of 1.9 million b/d in Iran and 1.3 million b/d in Iraq.
Between 1965 and 2015, however, Saudi production increased by 440 percent compared with 207 percent for Iraq and 105 percent for Iran.
Saudi Arabia’s crude and liquids production stood at 12.0 million b/d in 2015, which was three times higher than the 3.9 million b/d in Iran and 4.0 million b/d in Iraq (“Statistical Review of World Energy”, BP, 2016).
OPEC has struggled with the question of production baselines and output allocations throughout its history.
In the past, there have been proposals to base allocations on: current production; nominal capacity; historical output; proved reserves; population size; revenue requirements; and development needs (GDP per capita).
OPEC members have proposed allocations based on all these concepts at different times in the past without agreeing even in principle on which is the most suitable or equitable.
In practice, Saudi Arabia has usually decided how much to produce and cajoled the United Arab Emirates and Kuwait to accept allocations.
Iran, Iraq and other members have been left to produce as much as they are able given war, unrest and sanctions (“OPEC and other commodity cartels”, Alhaji and Huettner, 2000).
OPEC officials are currently struggling with how to come up with an agreement that cuts production in the short term without appearing to prejudge the question of long-term market shares.
Diplomats are paid to resolve differences and when that isn’t possible to come up with an agreement so complicated and ambiguous that everyone can claim to have won (or at least avoid the appearance of having lost).
OPEC’s negotiators have several options for trying to reach a suitably flexible and ambiguous agreement and appear to be utilising at least some of them.
The first is to make clear that any agreement on allocations is time-limited, leaving open the question of whether it will be extended or form the basis for future deals.
The second is to grant to selective exemptions, either explicitly or by allowing some members to state that they are not bound by their allocations. OPEC has used this tactic in the past.
The third and most important source of flexibility is creativity around the baselines where there are lots of opportunities for creative obfuscation.
The choice of reference period gives plenty of scope to adjust which members must cut the most and which must cut the least. Different members could even be given different reference periods.
In extremis, OPEC members could give up setting production levels and simply announce by how much each country will cut output, leaving the exact baselines undefined. OPEC has used this tactic before, too.
In the run-up to the ministerial meeting on Nov. 30, there is plenty of scope for creating lots of useful diplomatic confusion.
In the end, however, an agreement is as much about regional power as about oil revenues, and that means it goes beyond ministerial level to political leaders.
The question is whether Saudi Arabia, Iran and Iraq can reach a deal despite disagreeing about the regional power structure, or whether the wider competition for influence will torpedo an accord.
*John Kemp is a Reuters market analyst. Editing – David Evan.