(Bloomberg Opinion) -- Like so many in the past, the latest deal by the world’s major oil producing countries to reduce supply and boost prices relies on persuading the cheats to adhere to the output cuts they’ve agreed to. I don’t hold out much hope that they will change their behavior and that will leave Saudi Arabia with a choice between two bad options — continue to bear a disproportionate share of the burden, or open the taps to teach them a lesson.
Saudi Arabia’s new oil minister Prince Abdulaziz Bin Salman brought a quasi-religious language to his attempt to bolster a new output deal ahead of Friday’s OPEC+ gathering in Vienna.
“Like religion, if you are a believer you have to practice. Without practice you are an unbeliever.”
“I do not assume that anyone here in the room is an unbeliever, but I would reiterate to our friends that further commitment and further conformity would allow us all to benefit.”
That message was very clearly directed at Iraq and Nigeria — the members who have so far failed to meet their obligations under the existing deal — although he stopped short of naming them.
The new output target for Saudi Arabia — 9.744 million barrels a day — means that it is once again bearing the lion’s share of the burden. From an almost identical starting point, Russia is cutting about a third of that amount. But this time, while the kingdom is dangling the carrot of deeper, unilateral output cuts, it is also brandishing a big stick. The agreement, which comes into effect on Jan. 1, will be reviewed in early March and, to quote the post-meeting press release, “is subject to full conformity by every country.” The straightforward mathematics of oil deals leaves members with nowhere to hide.
Quite what Saudi Arabia intends to do if all members don’t comply wasn’t revealed. It has two obvious options, but each one will hurt the kingdom — and the new, mainly local shareholders in Saudi Arabian Oil Co. — alongside the laggards.
Saudi Arabia could turn a blind eye, as it has in the past. But that doesn’t seem in keeping with the style of the new oil minister. It was telling that his colleagues from the two countries with the weakest compliance record were both at the post-meeting press conference and were effectively invited to say how they would improve their performance. It almost felt like being witness to some kind of Maoist self-criticism session.
So what’s Saudi Arabia’s other option? It would be essentially to say, if you’re not going to pull your weight, then neither are we. This is exactly what the kingdom intimated it has in mind, I was told by a member of one of the other delegations at the meetings, who asked not to be named because he isn’t authorized to speak to the press.
The kingdom has tried this route in the past. The pump at will policy of 2014 was, in part, a response to the failure of other producers to regulate their supply — in that case U.S. shale producers. The output boost of December 1998 was also in part to punish Venezuela for its persistent over-production in the preceding months. And the switch to netback pricing in 1986, which saw Saudi crude prices set relative to the value of the refined products that could be made from it, was a response to the undercutting of official fixed selling prices by other OPEC countries over the preceding year.
Each of those output boosts triggered a spectacular price crash. And a similar response in March 2020 would have exactly the same effect. The prince no doubt hopes that the prospect of such an event will scare the laggards into complying.
If it doesn’t, he will have to decide which of the two unpalatable courses to follow. To retain any credibility, the kingdom will have to boost its production and take the consequential price crash, even if it brings unhappiness to Saudi Aramco investors at home. And make no mistake, the IPO is important to the prince — he took the opportunity of the post-meeting press conference to lambast the international media for what he saw as their negative reporting of the share sale.
Buckle up. We may be flying into some turbulence.
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Julian Lee is an oil strategist for Bloomberg. Previously he worked as a senior analyst at the Centre for Global Energy Studies.
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