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Last Updated: August 25, 2016
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One of the key factors which supported oil prices recovery last week was the news about some of OPEC's members who are calling once again for an output freeze deal. Positive comments were given by both, Saudi Arabia energy minister Khalid Al-Falih and Venezuelan President Nicolas Maduro, which lay the groundwork for a possible talk next month to discuss the possibility of oil producers freezing their oil output to support oil prices.

This is not the first time OPEC's oil producers give the oil market a hope that an output freeze deal could be reached. In fact, we still remember Doha's meeting and its disappointing outcomes. When we look at the situation now and then, we realize that there is no much difference.

Back then, oil prices fell below $30/bbl. The oil market sentiments were bearish, and many oil analysts were expecting oil prices to fall as low as $20/bbl. The direction in which the oil market was heading scared oil producers. And consequently, some of OPEC's members as well as other oil producers threw the idea of an output freeze deal. The duration since announcing the news of a possible output freeze deal until its actual meeting helped oil prices recover at that time.

But the result of Doha's meeting ended up with a failure to reach an output freeze deal, mainly because of Saudi Arabia's refusal to freeze oil output unless Iran does too. At that time oil prices were already well above $30/bbl, and the news didn't have much impact on oil prices. The oil prices rally continued on support from different factors.

In a similar way now, the news of a possible output freeze talk by OPEC's members came after oil prices fell below $40/bbl. Oil market sentiments were bearish during the last few weeks. U.S. crude inventories were not falling as expected and gasoline inventories were increasing. The increase in U.S. rig count was accelerating, and U.S. oil production recorded few increases during early to mid-July. Hedge fund managers increased their short positions and oil market analysts expected oil prices to fall sharply again.

These negative news scared OPEC's members again, and they decided to play the same old game. Announce a possible oil output freeze talk. Oil prices will stop falling, and reverse a course. Then, let the talk takes a month or more. The news of 'output freeze talk' throughout this period will help change the state of the oil market from negative to positive, just like it did few months ago.

When the output freeze meeting date comes, some producers will come up with an excuse not to agree on freezing their oil output. And the meeting will end up as a failure in a similar way like its previous version.

When that time comes, oil prices will be at a higher level. The oil market will be in a better state than it was a week ago. Other parameters will come in to support oil prices like what happened few months ago. And these oil producers talking about freezing their oil output right now will be producing more oil at that time.

OPEC's members are not freezing any oil output, they are simply playing the emotion game to help the oil market get through this difficult time.

They come in when the oil market is full of pessimism and negative sentiments, and they give it what it needs; a hope. That hope prevents oil prices from falling further and supports its recovery. The good news is, everyone wins in this type of games. And when the game is over, oil prices are higher.

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OPEC And The Current State of Oil Fundamentals

It was shaping up to yet another dull OPEC+ meeting. Cut and dry. Copy and paste. Rubber-stamping yet another monthly increase in production quotas by 432,000 b/d. Month after month of resisting pressure from the largest economies in the world to accelerate supply easing had inured markets to expectations of swift action by OPEC and its wider brethren in OPEC+.

And then, just two days before the meeting, chatter began that suggested something big was brewing. Whispers that Russia could be suspended made the rounds, an about-face for a group that has steadfastly avoided reference to the war in Ukraine, calling it a matter of politics not markets. If Russia was indeed removed from the production quotas, that would allow other OPEC+ producers to fill in the gap in volumes constrained internationally due to sanctions.

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The increase will be divided proportionally across OPEC+, as has been since the landmark supply deal in spring 2020. Crucially this includes Russia, where the new quota will be a paper one, since Western sanctions means that any additional Russian crude is unlikely to make it to the market. And that too goes for other members that haven’t even met their previous lower quotas, including Iraq, Angola and Nigeria. The oil ministers know this and the market knows this. Which is why the surprise announcement didn’t budge crude prices by very much at all.

In fact, there are only two countries within OPEC+ that have enough spare capacity to be ramped up quickly. The United Arab Emirates, which was responsible for recent turmoil within the group by arguing for higher quotas should be happy. But it will be a measure of backtracking for the only other country in that position, Saudi Arabia. After publicly stating that it had ‘done all it can for the oil market’ and blaming a lack of refining capacity for high fuel prices, the Kingdom’s change of heart seems to be linked to some external pressure. But it could seemingly resist no more. But that spotlight on the UAE and Saudi Arabia will allow both to wrench some market share, as both countries have been long preparing to increase their production. Abu Dhabi recently made three sizable onshore oil discoveries at Bu Hasa, Onshore Block 3 and the Al Dhafra Petroleum Concession, that adds some 650 million barrels to its reserves, which would help lift the ceiling for oil production from 4 to 5 mmb/d by 2030. Meanwhile, Saudi Aramco is expected to contract over 30 offshore rigs in 2022 alone, targeting the Marjan and Zuluf fields to increase production from 12 to 13 mmb/d by 2027.

The UAE wants to ramp up, certainly. But does Saudi Arabia too? As the dominant power of OPEC, what Saudi Arabia wants it usually gets. The signals all along were that the Kingdom wanted to remain prudent. It is not that it cannot, there is about a million barrels per day of extra production capacity that Saudi Arabia can open up immediately but that it does not want to. Bringing those extra volume on means that spare capacity drops down to critical levels, eliminating options if extra crises emerge. One is already starting up again in Libya, where internal political discord for years has led to an on-off, stop-start rhythm in Libyan crude. If Saudi Arabia uses up all its spare capacity, oil prices could jump even higher if new emergencies emerge with no avenue to tackle them. That the Saudis have given in (slightly) must mean that political pressure is heating up. That the announcement was made at the OPEC+ meeting and not a summit between US and Saudi leaders must mean that a façade of independence must be maintained around the crucial decisions to raise supply quotas.

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