The continued fall in oil prices have weighed heavily on the revenues of major oil producing countries such as Saudi Arabia and Russia, impacting their economic and social liabilities. The deal between Saudi Arabia, Russia, Venezuela and Qatar to freeze oil output to January levels is the most promising attempt to address the supply-demand imbalance on a global scale. This report outlines the likely impact of such a deal and the possible ramifications to the crude market.

Highlights

Saudi Arabia and Russia, two of the world’s biggest producers officially agreed to freeze production to January 2016 levels. OPEC members: Qatar and Venezuela; and non-OPEC producers, Mexico and Norway have also backed the agreement to freeze production.

Global crude oil supply is predominately made up of medium sour and light sweet grades.

Thomson Reuters Oil Research & Forecasts estimates that 96% of Iranian oil production in Q1 2016 will be medium sour crude.

Iran is a direct competitor to Russia and Saudi Arabia in the medium sour crude market. With Iran set to increase output, after the lifting of sanctions earlier this year, the production agreement appears to be an attempt by the world’s largest oil producers to maintain market share.

Thomson Reuters Oil Research & Forecasts estimates that almost 83% of the crude oil produced by Saudi Arabia during Q1 2016 will be of medium sour grade.

Over 80% of Russia’s crude output is of a medium sour blend. Urals, the Russian benchmark, is the main source of medium sour crude in Russia and accounts for 6% of global medium sour output.

In the medium term, moves by the Russian Energy Ministry to increase export duties for lighter oils and reduce taxes for heavier crudes is likely to increase the quality of Urals through blending, thereby raising the attractiveness of the crude to refiners. Ultimately, this will increase the premium of the Urals blend relative to other blends such as Iranian Light, especially as Iran is expected to offer more flexible pricing terms in an attempt to recapture market share in Europe.

Given the flexibility of US light tight oil (LTO) operations, a substantial price rally may incentivize producers to kick-start operations from the large number of drilled but uncompleted wells in the US.

US LTO is the predominant source of light sweet crude supply and could benefit from a production freeze that would only restrict medium sour crude output.

Medium sour crude margins in the Mediterranean may come under pressure if supply growth is restricted from a production agreement. Gasoline demand growth will increase the attractiveness of lighter grades while moves to shore up prices by Russia and Saudi Arabia could facilitate higher production, and in turn exports from US light oil operators.