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How OPEC Plans To Keep Rogue Oil Producers In Check

OPEC’s “whatever it takes” strategy has so far meant that Saudi Arabia would make additional production cuts where non-complying members failed. Some members are banking on OPEC employing that strategy again, and are using it as negotiating leverage.

This time around, though, the Saudis might not play big brother to their OPEC brethren.  The new threat is that compliance will have to be real this time around–from all members–or the cuts won’t happen at all. How successful OPEC will be in getting its noncompliant members to step in line, and how it will go about doing that remains to be seen.

Does OPEC have any other cards to play, other than Saudi Arabia’s motivation to go it alone?

OPEC’s Problem Child

The problem child of the cartel is Iraq, hands down. The country has consistently—and significantly—failed to adhere to the cuts. Despite this lack of follow through with the cuts, Iraq is in full support of deeper and longer cuts. And unlike some of the smaller OPEC members, its opinion and adherence to the deal are critical: Iraq produces more oil than any other OPEC member except for Saudi Arabia. Its production has doubled over the last decade, according to the EIA, and it produces nearly 5% of the world’s oil.

Aside from Saudi Arabia, no other OPEC member has as much production cut clout as Iraq. Unfortunately for OPEC, Iraq’s situation is beyond complicated. To understand just how complicated, and before a solution to their over-compliance can be uncovered, one must understand the nitty-gritty of Iraq’s oil industry.

Iraq’s disastrous political climate has occupied much of the country’s attention. It is unclear just how important, amongst all the civil unrest, the OPEC deal really is to it. What is important to it, however, is generating enough oil revenue to line the pockets of government officials.

Iraq’s oil industry isn’t like Saudi Arabia’s. While Saudi Arabia’s oil production is 100% under government control, Iraq’s state-run oil company controls only bits and pieces. Private oil companies do, and private companies, such as Lukoil’s 75% stake in one of Iraq’s biggest fields (400,000 bpd), West Qurna 2; and Exxon’s six production sharing contracts in the Kurdistan region and stake in West Qurna 1 (465,000 bpd), make it nearly impossible for Iraq to control its output—and that’s not even counting the oil production from the Kurdistan Regional Government, which Iraq has zero control over.

So what can OPEC do to get Iraq to snap to?

Not much, really. OPEC—or rather, Saudi Arabia—must convince the government of Iraq and the foreign oil companies operating in Iraq of two things: 1) that cutting production will lift prices, and therefore doing so is in everyone’s best interest, and 2) that Saudi Arabia will do most of the heavy lifting. And then together, their combined cuts will have more price-moving power.

Still, it’s unlikely that Iraq will be brought into full compliance. Why? Because Iraq and the Exxons and Lukoils of the world know that Saudi Arabia will do most of the cutting, even if they themselves noncompliant. Saudi Arabia needs the cuts more than Iraq does, and more than Exxon and Lukoil does.

There is little OPEC can do to alter the course of Iraq’s oil production.

Russia

On the non-OPEC side, Russia is the heavyweight, and it hasn’t been faithful to the cuts—a fact that has weighed on oil prices throughout 2019. Russia, unlike its Persian Gulf friends, is leery of oil prices that are too high. Higher oil prices would mean higher gasoline prices, and high gasoline prices would unsettle the public—the public that is supportive of Vladimir Putin’s economic policy—for now. Would they be so with higher gasoline prices? Putin is worried about the answer to that question.

Russia’s participation in the production cuts is just as critical, if not more so, than Iraq’s. Without its participation, OPEC members that have fallen on hard times such as Iran and Venezuela may decide not to participate themselves.   So what can OPEC do to sweeten the pot for Russia? First, it could grant Russia’s request to remove condensates from the production cut figures. Technically, this would mean Russia has already been complying, and so granting Russia’s request to remove condensates from the cuts, which none of the other OPEC members take into consideration, would change nothing except for public perception. But it is an important issue for Russia, who has increased its gas condensate production through an East Siberian field that went into production just a couple of months ago. Yahoo

Pix: OPEC headquarters, Vienna