Negotiations Over Oil Production Broke Down - but Not for the Reasons You'd Think

I've spent the last few days here in Abu Dhabi, the oil capital of the United Arab Emirates (UAE), to keep you up-to-date on discussions between OPEC and Russia. These negotiations were aimed at coordinating a cutting of oil production, which would lead to a movement up in global crude prices.

Unfortunately, any anticipation about the meetings here in Abu Dhabi was effectively negated over the past few days by three unexpected factors.

And while the Persian Gulf has long been the center of the world's energy markets, these three factors were, surprisingly, dictated elsewhere... the first one somewhere you'd least expect it...

The Unexpected Agreement That Will Change Energy Markets - Slowly

The first factor was the unexpected eleventh-hour climate "accord" reached in Paris. The agreement does signal a turn away from fossil fuels, although its real impact is likely to be muted. It will take more than just group photo ops to phase in this agreement.

That will be difficult to do, because despite signing some protocols, several of the primary culprits at the global meeting remain constrained by energy needs to continue doing what they are doing now.

Even if nations do end up putting some muscle where their rhetoric is, it will take years to see any tangible result.

In short, after the euphoria dies down, there will be a commitment to change, but also years of ongoing business as usual left.

On the other hand, the second factor hit the meetings here like a cold shower.

No One Wants to Blink on the Price of Oil First

It turns out that both OPEC and the Kremlin are into a game of "oily chicken." Each is waiting for the other to blink first. Even then, the blink is going to require intense central decision-making to pare down oil production and engineer budget adjustments as a result.

After all, every OPEC member and Russia remain dependent on crude export revenue for most of the revenue necessary to fill the public coffers. Central budgetary planning across the board among producing countries is now in shambles because oil has retreated below $40 a barrel.

Only in the United States, where unconventional (i.e., shale and tight) oil extractions have transformed the outlook for oil generally, is the budgetary outlook different. Here, no state-owned oil sector exists with a direct line into the national budget.

True, problems are intensifying for privately held companies, with the impact of bankruptcies and shelved forward capital commitments weighing heavily.

Dr. Kent Moors at the Sheikh Zayed Grand Mosque, Abu Dhabi, United Arab Emirates

Still, unlike OPEC countries and to a lesser extent Russia, the American economy is highly diversified. Lower oil output reflected in reduced future project commitments and rising sector insolvencies do translate into lower tax proceeds (especially on the more local level) and rising unemployment, while broader company cost-cutting decisions have their own ripple effects, adversely impacting both revenue and economic development.

Yet the effect has been offset by strengths elsewhere - both in the economy as a whole and within the energy segment itself. This is something that simply cannot be duplicated in the Middle East or on the tundra of Western Siberia.

Unfortunately, the demeanor of meeting participants turned south when the third factor hit. This one came like a sandstorm, from about 600 miles to the southwest...

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Saudi Arabia Put a Spanner in the Works

Riyadh, it turns out, was digging in.

The Saudi capital has let it be known that a restructuring of both the nation's revenue outlays and budgeting policies is underway. The message is clear. OPEC's main producer and strategy architect is revising how it subsidizes the domestic economy for the longer haul of lower oil prices.

The 600-pound gorilla not at the table just pushed back. Hard.

Now, the UAE and Kuwait to the north are (along with Saudi Arabia) the OPEC members most able to withstand the rising budget problems coming from protracted lower oil revenue.

Yet even in these countries, just about everything not directly related to oil must be imported and paid for in hard currency. That's why they are all now forced to revise internal policies and run expanded deficit financing to pay for expenditures.

The decision has been made to defend market share, not price. And it is on this battleground that the current impasse will play out.

But matters are even more desperate elsewhere in OPEC...

Iran and Iraq's Oil Production Plans Are Set to Hurt OPEC

Members like Venezuela, Nigeria, Libya, Algeria, Ecuador, and Iran are breaking under the weight of outright budget collapses. In each of these countries, the price for a barrel of oil must be well in excess of $120 to avoid a meltdown. In Caracas, that figure is more than $180.

That's not going to happen anytime soon.

What is already underway are some rather serious internal consequences of the low price of oil, a condition ongoing because of the Saudi-led decision to hold the line on market share. For example, national elections in Venezuela resulted in violence.

Meanwhile in Tehran, the Iranian government has given notice that it intends to increase both production and exports once Western sanctions are lifted (something still not happening anytime soon, despite an apparent nuclear accord). Across the border in Iraq, officials are also laying plans to increase oil production significantly and translate that into more sales abroad.

The problem is this. While both countries are members of OPEC, neither country has been affected by a monthly OPEC quota for some time - Iran because sanctions have prevented it from reaching the level; Iraq because its quota was suspended in 2003, when the latest Iraq war began.

Both of these national attempts to increase exports (and thereby revenue) will have to come from existing quotas held by other OPEC countries. That makes the situation for all of them even worse.

No wonder the Saudis are beginning to tighten the belt. Their policy moves are about to bring OPEC down around itself in internecine disagreement.

In the end, that shows us the real way by which oil prices will rise: Saudi budgetary problems, pressure from other OPEC members, and increasing global demand for oil.

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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