Market Insider

The 'dysfunctional family' known as OPEC could make oil prices crater

OPEC technical teams fail to reach output deal -Report
OPEC technical teams fail to reach output deal -Report

The word from Vienna is that things are not going well for OPEC. In fact, they are going surprisingly poorly.

The Organization of the Petroleum Exporting Countries meets Wednesday, and it was expected that the cartel could reach an agreement to cut back oil production. But the efforts appear to have hit a wall, even as talks continue. Analysts say a deal is still possible, but the odds have fallen with the appearance of disagreement between the major players.

The outcome of this meeting is being watched across financial markets because it could set the course for oil prices over the next year. If it fails, the market sees oil in the $30s per barrel in the near future, but if it succeeds, oil could stay above $50 and move higher. Oil was off about 3.5 percent in Tuesday trading, with West Texas Intermediate futures at $45.43 per barrel, and analysts say it could keep falling to around $42 unless a deal emerges.

"We're going to need somebody to go in and rescue it. This could end early tomorrow unless Khalid" — Saudi oil minister Khalid al-Falih — "can come in and restore order, but there's not a lot of time to get it done," said Helima Croft, head of global commodities strategy at RBC.

Croft, who is in Vienna, said the delegates are now awaiting the arrival of Al-Falih, and the outcome of the meeting is heavily dependent on whether Iran and Saudi Arabia can agree.

"What I hear is kind of crazy. The fear in town is it's Doha redux. Everybody's worst nightmare," she said. In April, OPEC ministers met in Doha, Qatar, amid high expectations they would agree to freeze production, but there was friction between Saudi Arabia and Iran, and there was no deal. Saudi Arabia insisted its rival join the freeze, but Iran held firm to its goal of regaining the market share it lost under economic sanctions on its nuclear program.

Saudi Arabia quashed what had looked like a possible deal in Doha in the final hour, and it was believed that Saudi Deputy Crown Prince Mohammed bin Salman made the call himself. But many analysts have said the Saudis are now more intent on a deal because of their planned public offering of Saudi Aramco next year, and the massive remake of the economy, led by the young deputy crown prince.

"Once again, it seems (Mohammed bin Salman) has decided Iranian participation in a cut is mandated. If he sticks to that position, it doesn't lift off tomorrow. I think a cut was never on the table for Iran. Is this just a hard-line tactic? Are they trying to get the maximum concession?" said Croft.

Now I'm wondering how ugly it's going to get. They're like a dysfunctional family. They tried to cover up their discord as long as they could.
John Kilduff
founder, Again Capital

Iran's energy minister arrived in Vienna, warning that his country was not going to make any cuts in production.

"We will leave the level of production (where) we decided in Algeria," Iranian Oil Minister Bijan Zanganeh told reporters as he arrived in Vienna on Monday.

In fact, Iran upped the ante by demanding that Saudi Arabia take even deeper cuts. Reuters reported that Iran now has written to OPEC saying that Saudi Arabia needs to cut back its output to 9.5 million barrels, a million-barrel-a-day cut. Saudi Arabia had indicated it would cut only half that amount.

"Now I'm wondering how ugly it's going to get," said John Kilduff, founder of investment management firm Again Capital. "They're like a dysfunctional family. They tried to cover up their discord as long as they could." Kilduff said oil could quickly touch $40 per barrel if there's no deal, before falling into the $30s.

The official posture of Saudi Arabia until this past weekend was that it was hopeful that a deal would get done, and that it was willing to do what it would take to make it happen. But over the weekend, Al-Falih signaled that he believed the oil market could rebalance without a deal, raising flags that the Saudi delegation might change its tone.

We're potentially going to fall apart over 200,000 barrels. This is what it comes down to. We're in the realm of ego … This is kind of lunacy. They're not fighting over a million barrels.
Helima Croft
head of global commodities strategy, RBC
Iran's Oil Minister Bijan Zanganeh arrives at his hotel ahead of a meeting of OPEC oil ministers in Vienna, Austria, November 29, 2016.
Heinz-Peter Bader | Reuters

In April, talks failed over a freeze in production, but now the negotiations are for actual cuts, the bulk of which would have to be made by Saudi Arabia. Croft said it seems that the disagreement is whether Iran accepts a production level 200,000 below what it says it currently produces. However, Iran says it produces 3.9 million barrels, and other sources put it closer to 3.7 million barrels a day.

"We're potentially going to fall apart over 200,000 barrels. This is what it comes down to. We're in the realm of ego. … This is kind of lunacy. They're not fighting over a million barrels," Croft said.

Iraq's role is also so far unresolved, despite comments from its oil minister that he was optimistic for a deal.

"It's between those three," said another analyst, referring to Iran, Iraq and Saudi Arabia.

"It's not going well so far," said the analyst, speaking from Vienna. "The issue has been if they are not going to cut, then what is the level that is established for them in terms of the base? What are they not cutting from? … When you're negotiating, do you want to reach a deal or not? If you want to reach a deal, you might have to compromise something. That seems to be the problem. Does everybody want to do a deal or not? There are some people who seem to think not at those terms."

Croft said the stakes are much higher at this meeting than they were in the spring. The Saudi population is hurting from cutbacks in domestic spending. Since the collapse in oil prices, the kingdom has rolled back energy and other subsidies. Bin Salman needs a higher oil price to make his goal of shifting to a more diverse economy work.

"I think the problem is who wants it more," Croft said. "We saw in September (Saudi Arabia) wanted it more. Maybe they wanted it more in September because they were doing a bond issuance." In fact, as it launched a $17.5 billion debt deal in October, the Saudi oil minister made bullish comments on oil, saying the long decline in oil prices was nearing an end.

"I think they'll probably still come up with an announcement. If there's no announcement, the market will fall below $40 a barrel very quickly," said Francisco Blanch, head of global commodity and derivatives research at Bank of America Merrill Lynch.

"They won't do it at any cost. That's shifted the tone of the negotiation and that's why we're seeing all these headlines, and the market is unraveling. There's a very obvious situation here where the Saudis are better funded than the other OPEC players. They've done their bond deal, and the expectation from Iran and Iraq was that the Saudis were going to bend over backward to get it done," said Blanch. Blanch said Saudi Arabia's very cooperative posturing in September at a meeting in Algiers may have been tactical, ahead of its bond offering.

Iran, Croft said, may not appreciate that there's a chance the U.S. could put it back under sanctions, once President-elect Donald Trump takes office.

"There's a new sheriff in town in the U.S., so that new sanction relief is not guaranteed by any measure," she said.