OPEC's "agreement-to-agree-to-an-agreement" in Algiers represents what we believe is the first step in this path to rebalancing the global oil market. Our original thesis was that the cuts were inevitable, something which we wrote about here.
We believe that there's still another shoe to drop, and that's Russia's involvement. Russia has been playing an active role in Algiers to help OPEC reach an agreement. As one of the key non-OPEC players in the last failed-Doha meeting earlier this year, Russia was keen to avoid any embarrassment in Algiers. As such, much of its role was behind the scenes this time.
According to Bloomberg, Russia, Algiers and Qatar served as mediators between Saudi Arabia and Iran, a role that allowed the parties to successfully reach a workable framework. Although a formal agreement/ratification of the framework will have to wait until OPEC's biannual meeting on November 30 (along with a formal assignment of new quotas to each OPEC member), we anticipate that Russia will announce its own cut/freeze either at the meeting or before.
I. Russia Produces at an All-Time High
According to the IEA, Russia produced 10.9M bpd in January 2016, and has since raised production to an all-time high of 11.75M bpd as of last week. Russia will likely average 11.1M bpd for September, a figure that Russia's Energy Minister, Alexander Novak, had previously stated was "a fully realistic level."
In contrast, Saudi Arabia produced 10.6M bpd in August, and from our initial understanding of the new OPEC framework, will likely see Saudi Arabia reduce oil production to its January 2016 levels of 10.2M bpd. This figure is largely reminiscent of the original Russia-Saudi agreement in February, when both parties agreed to freeze production at January 2016 levels, only to have that agreement scuttled because of Iran's refusal to participate. The difference in Algiers, however, is the added financial strain of the past year and the prospect of another painful 2017. Iran has also retreated from its intractable position that it be exempted from any production caps, a pill that's now easier to swallow since it has recovered close to 90% of its previous production output.
Russian oil producers have arguably weathered the storm better than its OPEC counterparts because the country depends less on foreign service providers. Thus, its production costs are largely denominated in the depreciating Russian ruble, while sales are made using the stronger US dollar. Even with this resiliency, curtailing production volume in exchange for higher prices means net/net the country will financially come out ahead.
We believe Russia and OPEC likely resurrected the earlier Russia-Saudi Arabia freeze proposal (i.e., Russia and Saudi agreed to freeze production at January 2016 levels), and coaxed Iran to come along in Algiers. If so, Russia would effectively remove another 200,000 bpd from supplies (difference between the average August and January 2016 production levels). Coupled with OPEC's framework, this will only further accelerate the drawdown of inventory. The next few weeks will see if OPEC can continue bringing this agreement home, but in the meantime keep an eye on Russia. It's about to join the party.
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