November 29, 2017

Political Conflict Won't Imperil OPEC Deal

Stratas Advisors

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Markets await this week’s 173rd Ordinary OPEC meeting in Vienna in anticipation that a decision to formally extend the current production agreement will be announced. This agreement was initially decided by OPEC member states and joined after by other countries such as Russia in November 2016. Implementation appears to have been successful in drawing down global crude stocks and supporting prices.  Currently, OPEC and its allies have agreed to extend the deal until March 2018, while Thursday’s meeting intends to discuss a prolongation to such agreement or a new one with similar terms.

However, since the last OPEC meeting, geopolitical tension and proxy wars have escalated between member states.  In Syria, Iran and Russia have provided decisive military support against rebel groups backed by Saudi Arabia and Qatar. In Yemen, Saudi Arabia has been conducting a heavy bombing campaign against Iranian armed Houthi rebels and directly accused Tehran of providing offensive weapons able to reach Saudi territory. The prime minister of Lebanon resigned in Riyadh, most likely under pressure from Saudi Crown Prince Mohammed bin Salman, and accused Hezbollah and Iran of being the roots of instability in Lebanon and in the region. Finally the GCC crisis is not over, Qatar is still under embargo which is resulting in Iran exporting USD $130 million worth of non-oil goods to Qatar, an increase of 117.5% compared with the same period last year.

Conversely, all of these conflicts could actually serve to reinforce the need for the agreement instead of making it fail. This is of course not the first crisis between OPEC member states, in the 80’s and 90’s during both the Iran - Iraq War and the Kuwait invasion, many member states had been carrying out proxy wars or even direct military confrontations, but they still collaborated when it came to OPEC agreements.  Given the ongoing physical confrontations many OPEC members are juggling, a high and stable oil price is necessary to fund these activities and maintain domestic political support. Moreover, MBS’s challenging reforms will be much easier to carry out with a higher Brent price; this means the Minister of Energy Khalid al-Falih will likely push hard to protect the agreement.

Regarding Russia, a meeting was organized between the Minister of Energy Alexander Novak and domestic oil companies to talk about the extension of the agreement for 9 months. It seems that all participants have agreed on the extension except for GazProm Neft, whose plans to launch new projects in 2018 require an increase in production.  While the companies may put up some resistance to a deal, Moscow maintains enough control over the oil sector as a whole that their compliance can be guaranteed.

The ongoing tensions in the Middle East are a key reason that Russia has been so supportive of a deal. President Putin is seeking to extend Russia’s sphere of influence in the region and by being a willing partner in the supply agreement he is positioning Moscow as an ally to the region. This should help counterbalance some of the blowback from Russia’s role in Syria.