A Solution For OPEC On Allocating Cutbacks

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Summary

OPEC started a price war on Thanksgiving 2014.

Saudi Arabia, UAE and Kuwait flooded the market.

Iran, Libya and Nigeria are trying to restore production to prior levels.

Seems equitable to have the Gulf producers cut to restore stability.

That solution could possibly achieve their goal.

On Thanksgiving 2014, OPEC ended its fateful meeting determined to combat the U.S. oil shale boom. Saudi oil minister "Naimi spoke about market share rivalry with the United States. And those who wanted a cut understood that there was no option to achieve it because the Saudis want a market share battle," according to one source.

But the price of oil dropped much more than the Saudis had ever expected, and the oil price depression has lasted much longer, burning through Saudi financial reserves at a rate of $100 billion per year. OPEC Secretary General Abdalla Salem el-Badri had admitted that OPEC was not "expecting" the dramatic 40% plunge in oil prices that materialized in just the weeks following that landmark decision in November 2014.

Click to enlarge

OPEC decided late September to change strategies and cut OPEC production to 32.5 to 33.0 million barrels per day. However, it appointed a High Level Committee to determine how to equitably achieve that.

The meeting of the High Level Committee failed at the end of October and again this week. Iran and Iraq balked at participating in any cuts and Nigeria and Libya are "exempt."

I went back to October 2014 OPEC data to assess their changes in production since then. Although output from Iran and Iraq is higher than it was back then, Iran is trying to restore its output to levels following disruption to its supplies. Iraq is battling ISIS and has been unwilling to cut back. However, its prime minister finally capitulated on Wednesday.

The three countries who are responsible for bringing on more output to sink prices are Saudi Arabia, UAE and Kuwait. As seen in the table below, they have together increased their output by 1.45 million barrels per day. It seems fair and equitable to me that they should reduce their output by that amount for the first half of 2017.

MMbd

Oct-16

Oct-14

Change

Proposed Cuts

Algeria

1.09

1.15

(0.06)

Angola

1.59

1.79

(0.20)

Ecuador

0.55

0.56

(0.01)

Gabon

0.20

0.22

(0.02)

Indonesia

0.72

0.67

0.05

Iran

3.69

2.80

0.89

Iraq

4.56

3.44

1.12

Kuwait

2.84

2.53

0.31

0.31

Libya

0.53

0.95

(0.42)

Nigeria

1.63

1.90

(0.27)

Qatar

0.65

0.69

(0.04)

Saudi Arabia

10.53

9.70

0.83

0.83

UAE

3.01

2.70

0.31

0.31

Venezuela

2.07

2.40

(0.33)

33.64

31.49

2.15

1.45

Click to enlarge


(Sources: OPEC, EIA)

Based on October production levels, that would bring OPEC output down to 32.2 million barrels per day, even less than the 32.5 target. That would allow some "headroom" for Libya, which is trying to get its output up to 900,000 b/d by year-end.

Conclusions

Putting the past two years into context, three Gulf producers were responsible for the overproduction policy. As such, they should be the ones to restore stability to the market through cutbacks. It seems unreasonable to expect countries whose production had fallen as a result of political problems to share in the burden created by the Gulf producers.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.