Did Saudi Arabia just blink on oil production? Jury is out

There's an old market saying: buy on mystery, sell on history.

Rumours are often more optimistic thanthe actual news, which was certainly the casewith the announcement that Saudi Arabia, Russia, Qatar and Venezuela will freeze oil production at January levels, if Iraq and Iran can be convinced to do the same.

Chatter that a deal was pending between OPEC and non-OPEC producerscaused oil prices to jump eight per cent last Friday. When the actual news came out, oil rallied briefly before losing ground and closing, once again, below $30 US a barrel.

The socialcontractin SaudiArabia is that we don't tax you, we give you all these generousbenefits and goodies from thestate, and in return, don'texpect any politicalvoiceortransparency.-BessmanMomani, University of Waterloo

The reasons are pretty clear. Even ignoring the fact that Iran has already declined to freeze its production, the move by Saudi Arabiaand others doesn't actually solve the problem of oversupply.

"We're producing about 1.5 million barrels a daymore than the world is consuming," said Jackie Forrest, vice-president of energy research at ARC Financial.

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In January, Russia was producing nearly 11 million barrels of oil a day andSaudi Arabiajust over 10 million barrels per day. While not a record, those are still historically high levels that do nothing to ease the glut.

"What it does do is ease the risk that oil will drop further from here," said Forrest.

Iran not onside

Shortly after the announcement was made in Qatar, Iran said that it does not intend to freeze production. Earlier this week after the lifting of sanctions, Iran sent its first oil tanker in four years to Europe.

Iran wants to win back the market share that it lost to Saudi Arabia and other countries while under export sanctions for its oil.

In January, Iran said that it intended to increase production by 500,000 barrels a day.The country is thought to have46 million barrels of petroleumstored offshore and up to40 million barrelsstored on shore. It wants that oil to getto market.

For its part, Iraq is producing record amounts in order to rebuild and to fund its war with the Islamic State. Oil ministers from those countries and Venezuela meet in Tehran today to talk details.

The Wall Street Journalreported that Iran may be offered a special deal to increase its output above January levels.

Something like that will probably be needed, said Forrest."Iran just had its sanctions lifted. It's very difficult to get an agreement across all of OPEC until Iran can really prove out how much production they ultimately can bring online."

Did Saudi Arabia blink?

Saudi Arabia has been playing the long game with theoil market since November 2014, when OPEC first declined to cut production in reaction to falling prices. Until now, it appeared to ignore allpleasto support the market.

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And while Saudi Arabia still has a huge cash buffer, it is feeling the pain, running a deficit close to $100 billion, increasing fuel prices and implementing a sales tax, its first tax on citizens.

"The socialcontractin SaudiArabia is that we don't tax you, we give you all these generousbenefits and goodies from thestate, and in return, don'texpect any politicalvoiceortransparency, and definitely no representation," said BessmaMomani, a political science professor at the University of Waterloo.

As the money tree has started to dry up, there have been mutterings of discontent.

"What we've seen online in terms of domesticdiscontentis: 'Where is all the money? Why are we in thedarkon things?'" said Momani.

"Andmore importantly, if you aren't going togive us these generous benefits, whyshould we hold up our end of the contract in terms of being apathetic citizens?"

"That's basically a political risk that Saudi Arabiawas taking."

Reason for optimism

Saudi Arabia's willingness to at least freeze production remains a positive sign for the energy market.

Bloomberg reported Tuesday that diplomats have been working behind the scenes for a year to forge a deal that will see both OPEC and non-OPEC producerscut production.

That was the first step. The meetings today in Tehran with representatives from Iran and Iraq will mark the next phase of negotiations.

Forrestbelieves that there is a path to a balanced oil market by the end of the year, if three things happen: Demand continues to grow;Iran brings a limited amount of production to the market;and gains by Iran are offset by production cuts in the rest of the world.

That may sound like a tall order, but she says all three are likely atcurrent prices.

"If all those three thingshappen, we could have abalanced market by year end and that would mean stronger prices."