Will Saudi Arabia Draw A 'Red Line' In The Negotiation?

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Summary

Despite numerous expressions of optimism by OPEC and Russia's oil officials, the production control agreement will likely be a last-moment event.

The negotiation process among most important constituents appears far from over and a risk of significant surprises will likely exist through the very end.

During the announcement phase, the success of the initiative appears to be hinged on Saudi Arabia's readiness to walk away from the deal and default to market mechanisms.

The November 30 OPEC meeting in Vienna will be a challenge to Saudi Arabia's resolve and a test to its current de facto leadership position among oil exporters. To bring the much advertised production control pact to fruition, Saudi Arabia must be prepared to walk away from the deal if its OPEC and non-OPEC partners do not cooperate in good faith.

Needless to say, implications of walking away could potentially be severe for Saudi Arabia itself as well as for other participants. OPEC's failure to put together a production control agreement after seemingly being very close to success would likely convince the market that the cartel is indeed incapable of supporting prices, and market forces are the only mechanism that will rule the oil market going forward. Moreover, a collapse of the negotiation process could also raise fears that Saudi Arabia and its GCC allies would increase production volumes, with a risk of oil prices going into another tailspin, similar to the one that occurred in early 2016. As a result, price consequences of a failed production control pact could potentially be quite painful for all producers.

However, without drawing a "red line" in the negotiation and being prepared to defend it, Saudi Arabia is facing a risk of ending up with a visibly hollow agreement where it is the only party assuming tangible obligations, exactly the outcome that Saudi Arabia had stated it would not accept.

It is important to note that while the new quota agreement is expected to cover all OPEC members and several non-OPEC producers, the real issue are quotas for large exporters who can grow production volumes in a low-price commodity environment. Those producers are relatively few, which makes the negotiation process manageable. In this regard, Iran, Iraq and Russia are obviously among the most important parties to the pact. It is no surprise, therefore, that the greatest uncertainties relate to the negotiations involving those countries.

At the end of the day, there will be a moment when Saudi Arabia would need to put on the table a final "all or nothing" proposal. Such proposal would have to contain two critical elements: a generous concession with regard to its own production quota (possibly in combination with other GCC producers) and a clear and credible communication that no further negotiation can be entertained. The first element appears to have already been proposed as Saudi Arabia is insisting on a deep cut in OPEC supply to 32.5 MMb/d. Given that Iran, Libya and Nigeria are expected to be offered some headroom, a deep reduction would not be realistically possible without Saudi Arabia shouldering the lion's share of the cut.

With regard to the "all or nothing" line, it is not clear if it has been drawn yet and whether it will be. Public comments being made by key participants, including Russia, Iran and Iraq, continue to be vague and conflicting. At the same time, all officials go out of their way to express confidence in the unity of the effort and "highly likely" success of the production control agreement.

For example, Iraq's oil minister in an official statement implied that Iraq plans on continuing negotiations during the meeting in Vienna. The following was circulated by Iraq's government news agency yesterday:

Oil Minister: Iraq Holds New Ideas And Proposals For The Next Ministerial Meeting of OPEC

BAGHDAD, November 21 / NINA / - Iraqi Oil Minister, Jabbar Ali Hussein Laibi confirmed Iraq's keenness on the unity and strength of the Organization of Petroleum Exporting Countries "OPEC" in stabilizing the world oil market and support oil prices.

Laibi said in a ministry statement: "The Iraqi delegation to the next ministerial meeting of OPEC at the end of this month will carry new ideas and proposals aim[ed] to make great convergence and consensus among OPEC's members to reach an agreement guaranteeing to achieve common goals for the producers, including the stability of the market and support oil prices to acceptable levels."

He pointed out that "Iraq has been and continues to play a positive and clear role in dealing with the issues and challenges and market volatility faced by OPEC."

He stressed that "Iraq reaffirms his commitment to the unity and cohesion of the organization and his legitimate demands should not be understood as an obstacle to reaching a new agreement to freeze production, and Iraq relies heavily on the next meeting on the concern and efforts of members and producers from inside and outside the organization and the wisdom of the Secretary-General Mohammed Barkindo to reach just and fair agreement takes into account the interests of all and put an end to the oversupply of crude oil in the global market."

One thing appears clear: similar to the informal meeting in Algiers in September, negotiations are likely to continue till the eleventh hour, keeping the market on edge until the very last moment. Last-minute surprises, in both directions, cannot be ruled out.

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