clock menu more-arrow no yes mobile

Filed under:

Saudi Arabia and Russia reached a deal to cap oil production

David Hecker/Getty Images

Saudi Arabia and Russia, the world's two largest oil producers, joined Qatar and Venezuela at a big OPEC meeting to announce a plan to cap oil production and bring a halt to the slide in crude oil prices that's rocked global markets over the past couple of years.

But don't expect it to work.

The key problem is that even though Saudi Arabia and Russia are huge producers of crude oil, they haven't been responsible for much of the recent increase in oil supply. So capping production at January levels, which is what they are talking about, won't necessarily do much to prevent new supply from coming online. The real sources of new crude are Iran and Iraq, and they're not party to the deal.

Iran has no reason to cap oil production

Iran, as you have probably heard, recently signed a major diplomatic agreement with the United States and other world powers, whose terms involve verifiable nuclear disarmament in exchange for sanctions relief. The main points of this from an Iranian point of view are to make it easier to export oil and to make it easier to import the foreign capital, equipment, and expertise needed to increase domestic oil production.

Under the circumstances, agreeing to a production cap would amount to giving up the lion's share of the gains from the deal with no real upside.

Somewhat similarly, Iraq has been steadily increasing its oil production as part of the postwar rebuilding process but continues to see output hampered by security problems. The Iraqi government may or may not manage to make further progress in securing oil facilities from the Islamic State, but if it does succeed, the Iraqis are going to do everything they can to bring that oil to market and give it the revenue it needs to fight the insurgency.

The USA is the sleeping giant of oil production

Last but by no means least, the United States — the world's No. 3 producer of oil — isn't party to any such deal and doesn't even attend these kinds of meetings, because we are net importers of crude oil.


American production is down a bit from its highs in the summer of 2015. But that's not a policy decision to cut production, it's not security problems, and it's not a lack of exploitable oil resources. What's stymied US production is that the price of oil fell steeply enough that the pace of new drilling collapsed.

That's been the one ray of good news for Persian Gulf oil producers in 2016. But it also in effect puts a cap on oil prices. Even if the Saudis and the Russians could get Iran and Iraq on board for production cuts to raise prices, if prices rise too much, US production will come roaring back.

Fear of this scenario is precisely why Saudi Arabia has thus far been reluctant to agree to meaningful production cuts. Today's agreement reflects less a change of heart on that score than a desire to create the appearance of progress by reaching a diplomatic deal that isn't so meaningful.