Earlier this week, Ecuador's Oil Minister Carlos Perez announced that the country would no longer abide by its commitment to the Vienna Accord.
That's the OPEC-Russia deal to cut oil production and boost prices.
Now, pundits have been quick to misinterpret that as the first splintering of OPEC on its oil price regimen.
Actually, it may indicate far less than meets the eye.
Now, the Vienna Accord took effect in January.
Despite some questions about the equation between production on the one hand and exports on the other, that agreement had held. It initially supported higher prices.
However, that scenario has more recently come under some pressure from the stubborn rise in production in the United States (not a party to the OPEC/non-OPEC deal).
In the aggregate, OPEC remained faithful to the commitment with the association at or above the 100% compliance level until June. After that, there had been some retrenchment amid signs the agreement might be experiencing some pushback.
Some of this has been the frustrating recent decline in prices as OPEC exports as a whole began to increase - and American production rose even higher.
And then there was the signal from Saudi Arabia that the basis for the accord may be wearing thin. Riyadh telegraphed both a rise in production and in exports.
Still, no OPEC member officially indicated it would not abide by its part of the cuts... until Monday. Ecuador became the first.
Ecuador's Oil Production Is in China's Hands Anyway
Now to put this in perspective, as one of the smallest OPEC producers, Ecuador had been contributing less than 17,000 barrels a day to the effort.
And then there's the reality behind the cash-strapped nation's situation.
As I discussed in Oil & Energy Investor a few years ago, heavy Chinese loans to both the central government and national oil company Petroecuador resulted in the country becoming the first OPEC member to lose control over its own crude oil exports.
Instead, oil revenue was now under the control of Beijing as repayment for the debt incurred.
The situation facing Ecuador had telegraphed what could be the future for both Brazil and Peru, where Chinese funds had also been advanced. It also demonstrated that the lending policy had morphed.
Initially, the loans had resulted in exports of oil back to mainland China. Now, the target end user of the oil was less important to Beijing than the control over revenue.
But Ecuador's defection has introduced the prospect of a broader unraveling of the entire Vienna Accord.
In his defense, Perez had noted that his country has some flexibility in addressing its OPEC production quota. While never made public (these sidebar concessions rarely are), my sources confirm the arrangement exists.
But to see whether Ecuador's "defection" - with an out or not - will result in the rest of the signatories of the Vienna Accord will fall like dominoes, we need to look at this from a different perspective...
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Why Ecuador's "Defection" Doesn't Matter
You see, there are other prospects afoot that indicate the current OPEC production levels are likely to be maintained and may even be deepened.
First, the Saudis introduced the possibility that Libya and Nigeria be included in the cuts.
Under the current deal, both countries, despite being members of OPEC, are not included in the accord. Nigeria has thus far rejected the idea of cutting production.
Yet the realities within both are already producing the same result. Nigeria has renewed fighting in the Delta, once again putting primary oil production in jeopardy. Civil unrest is again expanding while the central government is unable to protect oil drilling from insurgents.
My contacts in foreign companies operating there indicate a paralysis in extractions is already underway.
The Libyan environment is even less stable. This is not civil unrest. It is civil war and it's intensifying.
Both fields and export facilities are once again at risk. This is going to be a continuing source of uncertainty moving forward. The overwhelming view among observers is that it will lead to overall lower production and export totals.
Second, the OPEC member widely thought to be the main candidate for "first defection" has mounting problems of its own.
Venezuela is experiencing a massive and worsening financial crisis.
National oil company PDVSA is suffering an accelerating contraction in production at the same time as its debt becomes untenable. The daily production level is now down to 1.9 million barrels, the lowest in more than 25 years.
This despite Venezuela having the largest reserves in the world, greater than even Saudi Arabia.
But this is heavy oil situated in the Orinoco River belt. It requires massive capital infusions and technology to develop.
PDVSA cannot provide either. To make matters worse, as this export revenue flow shrinks, Caracas is also subject to an increasing amount of it having to go to repay Chinese and Russian loans.
Venezuela's Collapse Would Overshadow Anything Ecuador Can Do
There's a consensus emerging among international market players I talk to that PDVSA is going to experience what amounts to an implosion in short order.
The central government is already showing all the signals of a failed state. PDVSA, meanwhile, has begun to reflect the elements of a failed national oil company.
The difference between Ecuador and Venezuela is a marked one. The former is a minor cog in the global oil picture. The latter has been a huge factor.
The Venezuelan decline in both production and exports will be more important in maintaining the OPEC decline in both than any other consideration.
Finally, Riyadh has introduced its own contribution.
The Saudis have indicated they may be prepared to cut almost 1 million barrels a day from their own production levels. Remember, we are now in the initial rollout of a 5% IPO in Saudi Aramco, the largest state-controlled oil producer on the planet.
The value of that float depends upon the underlying value of Aramco. That, in turn, requires as high a market price for crude oil as possible, thereby obliging the Saudis to support a rise in price.
The IPO should result in the largest sovereign wealth fund ever constructed. That fund will result in massive worldwide investments intended to diversity Saudi revenue flows.
And that may be a compelling reason for a Saudi decline in oil production as the country moves into its post crude period.
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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.