Last Days For OPEC’s Quota System

Temporary Reprieve by Libya and Iraq

Taking OPEC Secretariat official figures as recent as April­May 2014, before the June 11th OPEC meeting in Vienna, the Secretariat was able to state that “OPEC member states [conforming to the quota system] collectively produced slightly less than the 30 million barrels/day Crude ceiling volume”.

In other words the quota could be rolled over yet again, markets would not be oversupplied, and prices would stay “comfortably” firm and high. However, this statement from OPEC admitted that “unscheduled outages and production losses” in

the 12 member states supposedly complying with the 30 Mbd maximum output target, in May, were running at about 2.5 to 2.6 Mbd. After these outages and for May, it said that the member states complying with the quota system produced a combined average total between 29.9 and 30.26 Mbd.

Then we bring in Angola's production, estimated at an average 1.73 Mbd in May, Libya's struggling and highly variable production however estimated, by the OPEC Secretariat, as “about 0.6 Mbd” in May, and Iraq's slight decline in production, from 3.3 Mbd at end­2013, to 3.1 Mbd in May.

Adding these, we get another 5.43 Mbd, to add to the official but theoretical 29.99 Mbd. OPEC states likely produced a total of more than 35 Mbd in May 2014. When or if the unscheduled outages are restored to full production, we could raise this capacity as high as 37.5 Mbd. OPEC has no problems overproducing. Other players, in the financial and trading sector have to ensure that prices remain “comfortable” ­ for producers only!

Intermittent States and Oil Output

As recently as April­-May, the OPEC Secretariat's main worry was Libya – returning to full production and driving a big new hole in claims that “the 30 Mbd ceiling” was holding and could hold. The embattled authorities in Tripoli and Cyrenaica's own authorities, in the oil­producing east which also holds the majority of oil export terminals, strike periodic and shifting agreements for restarting fields or reopening oil ports. Overall, the general security situation suggests that the likelihood of stable production at levels anywhere near the pre­revolutionary, Gaddafi­era average of 1.6 Mbd, anytime time soon, is small but the possibility of Libyan crude output recovering to an average around 1 Mbd cannot be ruled out.

In Iraq, security concerns were already heavily weighing on claims, by the el­Maliki government and Iraqi oil ministers at OPEC meetings that Iraq “would soon achieve 4 to 4.5 Mbd” ­ and would rejoin the OPEC quota system! While the second is possible – because Iraq's oil production is very likely to stagnate or decline, not increase – the first claim is pure and simple grandstanding.

As I note in several recent articles, there are also technical issues which cast doubt over whether Baghdad will be able to capitalize on new production from major fields in the south, despite massive Russian and international oil major corporate investment.

The country has overtaken Iran as OPEC's second biggest producer but Iran has every intention of reversing that situation by raising its own output – this is one key reason Iran wants an end to sanctions. Iran's oil output has been “artificially hobbled” and in no way can be considered stuck at its present rate of about 3.25 Mbd, but current technical limits have resulted in a throttling back at several fields. On January 10, 2014, oil minister Bijam Zanganeh said Iran earned $34 billion through exporting an average 1.2 Mbd of crude oil and gas condensates in the first nine months of the current Iranian calendar year, which began on March 21, 2013. In December 2013, minister Zanganeh claimed that Iran could boost production by 20% to 4 Mbd by end­2014 if sanctions are lifted. Iran has earmarked 1.5 Mbd export sales by late 2014 in its national budget, needing at least 0.3 Mbd extra output.

Oil Price and Production

Intrinsically and basically linked with oil production and export supply trends, the oil price is critical. In the case of Iran, for example, oil minister Zanganeh retains an average international oil price of $107 a barrel, for his policy and programmes. In Iraq the same price­logic applies, but basic security­linked issues such as pipeline and refinery upkeep and maintenance defy that logic.

Well before the ISIS invasion, in the north, the security situation is so bad that repair teams are unable to get close to the key Iraq­Turkey crude pipeline since an attack by insurgents closed the line in early March.

The USA's stunning increase in combined shale gas and shale output bringing their combined oil equivalent total above the oil­only production levels of Russia and Saudi Arabia in less than 6 years, is largely or exclusively due to high oil prices. The shift to “unconventional oil” also operating in the case of deepwater provinces such as offshore Brazil, the GoM and offshore east

Africa ­ depends on high oil prices – but the inevitable risk is overproduction.

Backtracking to the case of Iraq we can note that the 1991 Desert Storm­ Gulf War I was in part triggered and accelerated by Saddam Hussein's invasion of Kuwait resulting in oil market prices spiking – to about $46 a barrel! In 1998, the UK 'Economist' magazine felt able to forecast oil prices in 2000­-2010 falling “to as low as $5 a barrel”.

Oil producer country discipline when faced with seriously declining prices – and seriously limiting output to restore prices – is for the least unsure. Saudi Arabia, in oil lore and myth, has the vaunted role of “swing producer” but when confronted by the oil price crash of late 1986 slashing oil prices by about 67%, Saudi Arabia's “voluntary production cut” held for less than 2 years. By 1989 it had fully restored production to 8.5 Mbd – despite prices staying low, or very low for another 10 years!

Today's oil production context of rising unconventional oil output driven by high prices and easy borrowing for mega­investment projects, and unrealistic claims by OPEC states that they are maintaining total output “at 30 Mbd or below” ­ and an oil demand context that remains lacklustre to say the least – bodes ill for oil prices. To be sure the near­term is influenced by the Iraq crisis, but the erosion of prices nearer to actual production cost suggests that price decline cannot be held off for an indefinite period. The eccentric and outdated OPEC quota system is a bellwether for this change.