Oil: Prices, Production Negotiations, and Market Stabilization Unlikely

Oil closed on Friday at 36.79 US dollars per barrel, nearly one third of the price of 18 months ago (NASDAQ). The recent sharp falls in oil prices have caused heated debates about what the level of oil production should be to stabilize the oil market.

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(NASDAQ/Barchart Market Data Solutions)

Crude oil prices have been on a declining trend over the last 18 months.

Venezuela, Saudi Arabia, Qatar, and Russia reached an agreement in February to freeze oil production at January levels. However, it does not seem that the countries wish to keep doing this and most likely will not. Oil market stabilization seems a long while away, and it will probably not happen through this method. The lack of a solution can be problematic for both exporters and importers of oil.

There is (supposedly) another planned meeting among the various Organization of the Petroleum Exporting Countries (OPEC) members on April 17 in Doha, Qatar. At this meeting, the nations are going to decide to freeze the production for a longer time or to increase it again. Decreasing production is very unlikely.

Whether these negotiations will be successful or effective at all remains to be seen. Many countries do not want to freeze or decrease production or will only do so if other countries do the same.

For example, the deputy crown prince of Saudi Arabia, Mohammed bin Salman, explained in an interview with Bloomberg that if other countries (especially Iran) freeze production, so will Saudi Arabia:

“‘If all countries agree to freeze production, we’re ready…If there is anyone that decides to raise their production, then we will not reject any opportunity that knocks on our door’” (Micklethwait, Hamade, Blas 2).

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(Saudi Arabia’s Royal Court/Bloomberg)

Saudi Arabia’s deputy crown prince, Mohammed bin Salman, explains Saudi Arabia’s desired course of action.

However, Iran does not want to cut production because sanctions against the whole country were just recently lifted. Iranian Oil Minister Bijan Namdar Zanganeh will go to the meeting but will not freeze production because the country wishes to make up for the lost share in the oil market that resulted from sanctions (Micklethwait, Hamade, Blas 2).

Other countries have expressed the same opinions. Kuwait and Iraq have expressed the same opinion as Saudi Arabia, and no representative from Libya will go to any meeting this month. Libya wants to keep production at the level before its 2011 civil war (Bourgeault 2). Russia did not follow the February agreement in the month of March, increasing production very slightly to 10.912 million barrels a day from 10.91 million in January.

Even if the meeting happens and the agreement passes this month, there will still be a major excess supply of oil, according to the International Energy Agency. This is because a freeze in production should give the countries an incentive to decrease production in the long run, which would be the real driving force behind increasing oil prices (Bourgeault 4).

The OPEC nations all share the common goals of increasing the price of oil and eliminating the excess supply. However, this cannot happen given the level of disagreements in many different dimensions: “Countries including Russia, Kuwait and Venezuela can’t agree on timing. They are at odds over whether Iran would be bound by a production cap. And they have been unable to reach a consensus on where to meet to discuss their differences” (Faucon, Said 1).

Oil will probably remain a vital commodity (as a raw material) well into the future, so the issue must be resolved. If the OPEC members are really concerned about keeping their profits high at all costs, then they could decrease production to the level that they think would cause the price to be about 90 or 100 dollars per barrel. However, this would cause many of the economies that import oil to be harmed (similar to the oil price hikes of 1973 and 1979).

The US is dealing with potential federal funds rate hikes this year. An increase in the price of crude oil would delay that increase, and the US consumers would most likely not buy as much oil.

The best solution would be to cut oil prices and production until supply meets demand. However, the equilibrium is hard to find, and it will probably not happen anytime soon. The countries will remain in a production glut until they can agree.

 

References:

Bourgeault, Gary. “Oil Production Freeze Initiative Quickly Unraveling.” Seeking Alpha. Seeking Alpha, 24 Mar. 2016. Web. 03 Apr. 2016. <http://seekingalpha.com/article/3960785-oil-production-freeze-initiative-quickly-unraveling&gt;.

“Crude Oil.” NASDAQ.com. Barchart Market Data Solutions, 01 Apr. 2016. Web. 03 Apr. 2016. <http://www.nasdaq.com/markets/crude-oil.aspx?timeframe=18m&gt;.

Faucon, Benoit, and Summer Said. “Oil Output Negotiations Hit Obstacles.” WSJ. Dow Jones & Company, Inc., 14 Mar. 2016. Web. 03 Apr. 2016. <http://www.wsj.com/articles/oil-output-negotiations-hit-obstacles-1457964034&gt;.

Micklethwait, John, Riad Hamade, and Javier Blas. “Saudi Arabia Will Only Freeze Oil Production If Iran Joins.” Bloomberg.com. Bloomberg, 01 Apr. 2016. Web. 03 Apr. 2016. <http://www.bloomberg.com/news/articles/2016-04-01/saudi-arabia-will-only-freeze-oil-production-if-iran-joins-plan&gt;.

“Opec and Russia Oil Production Freeze Is Meaningless Gesture, Says IEA.” The Guardian. Guardian News and Media, 23 Mar. 2016. Web. 03 Apr. 2016. <http://www.theguardian.com/business/2016/mar/23/opec-and-russia-oil-production-freeze-a-meaningless-gesture-says-iea&gt;.

Rudnitsky, Jake. “Russian Oil Output Rises to Record as Freeze in Doubt.” Bloomberg.com. Bloomberg, 03 Apr. 2016. Web. 03 Apr. 2016. <http://www.bloomberg.com/news/articles/2016-04-02/russian-oil-output-rises-to-record-as-production-freeze-in-doubt&gt;.

 

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One Response to Oil: Prices, Production Negotiations, and Market Stabilization Unlikely

  1. tamsasabat says:

    It is obvious that why and how nations are waiting for each other to take the first step. The behavior of the players where each nation is adopting the strategy to wait and watch in the hope that some other nation will probably take the first step sounds quite intuitive and reminds us of the theory of prisoner’s dilemma – the Game Theory. This is a common phenomenon witnessed in oligopoly markets where players are in a situation in which each has 2 options and its outcome depends on concurrent choice made by the other. Over here too, every player wants to avoid being the first one to slash oil prices in the fear that its government will have to bear loses and other countries may not follow suit. This condition is unsustainable in the long-term as it is pushing the demand down heavily which would in-turn hurt these nations’ income. Its difficult to think of a probable solution to this problem indeed.

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