As cracks emerge in global oil pact, Saudis may need to compromise

Tough negotiations await a group of OPEC experts as they meet their counterparts from other oil producers such as Russia on Oct. 28-29 to hammer out details of an output-capping agreement, with disagreements threatening to scupper the deal.

OPEC agreed in Algeria last month on a modest oil-production cut in the first such pact since 2008, with the group's top producer Saudi Arabia softening its stance on arch-rival Iran amid mounting pressure from low oil prices.

But cracks have surfaced in the Algiers agreement, which would reduce output to a range of 32.5-33 million barrels per day (bpd), and Saudi Arabia may have to offer a major concession if it wants to cement the accord.

Saudi Arabia and its Gulf OPEC allies are already willing to cut 4 percent from their peak oil output, energy ministers from the Gulf countries told their Russian counterpart this week, sources familiar with the matter told Reuters.

Iraq, OPEC's No. 2 producer, said this week that it would not cut output and should be exempted from any curbs as it needs funds to fight Islamic State. Baghdad's stance is likely to face opposition from Riyadh and its Gulf allies, OPEC sources said.

"I expect it to be a very tough meeting," one OPEC source said of the expert talks in Vienna.

"If there is a cut, then everyone must cut. No exemptions," the source said, commenting on Iraq's demands.

There is a general understanding that only Libya, Nigeria and Iran should be exempt as their output had been hit by wars and sanctions, three OPEC sources said.

The Organization of the Petroleum Exporting Countries estimates its output at 33.39 million bpd, meaning it needs to cut about 400,000 to 900,000 bpd to meet its target.

OPEC has yet to agree at which level Iran would freeze production, with Tehran having emerged from years of sanctions and aiming to regain market share.

Iran has said it is producing 3.85 million bpd, close to its pre-sanctions output of 4 million bpd.

A source familiar with Iranian thinking said Tehran was unlikely to match its pre-sanctions output this year.

"We are not going to harm the market by drastically increasing production ... We have done much of the work, there is 200,000 to go and that will take a year," the source said.

SAUDIS "DESPERATE" FOR A DEAL

An attempt to bring non-OPEC Russia, the world's top oil producer, into a cut deal was rebuffed by Russian Energy Minister Alexander Novak in Riyadh on Sunday during a closed-door meeting with Gulf energy ministers, the sources said.

"The Russian minister told the ... ministers that Russia will not cut production. He said they have been talking about a freeze, not a cut," said a source who was briefed on the talks.

Another source confirmed that the message from Moscow was that Russia is not ready to cut and can only freeze output at current levels of 11.11 million bpd, a record high.

That would require a bigger Saudi concession and deeper cuts by the kingdom to stabilize an oversupplied market and prop up prices that stand well below the budget needs of most producers.

Most analysts say Saudi production will fall in winter anyway as the summer heat eases, reducing the need for cooling. State oil giant Saudi Aramco also plans to shut two refineries towards the end of this year for maintenance, which could mean reducing crude output by as much as 700,000 bpd.

The 4 percent cut offer by the Gulf OPEC bloc is likely to be made at this week's meeting of OPEC and non-OPEC experts in Vienna, the sources said.

Riyadh's highest output was reached in July at 10.582 million bpd, according to OPEC secondary sources.

But such a reduction may prove insufficient if Iraq insists on being exempted, and as Iran has said it is pumping 3.85 million bpd - about 185,000 bpd higher than estimates of the country's September production by OPEC secondary sources.

Riyadh has historically shouldered the lion's share of OPEC cuts. But if it took the same route this time, it could lose oil revenue if prices failed to rise while others increased production. The Saudis could also lose market share.

"They (the Saudis) are desperate for a deal," an OPEC source said.

Riyadh faces a second year of record budget deficits and is cutting the salaries of government employees, so keeping its output at current levels of 10.6-10.7 million bpd may not be economical.

Industry sources say Aramco cannot sustain such high output for long, as it sees 10.1-10.2 million bpd as a more comfortable level also for its oilfields and reservoir management.

"It's a question of how do they want to spend the limited budget that they do have," an OPEC watcher said.

"They have tough choices. Clearly as Saudi production goes up, their costs go up too."

THORNY ISSUES

The OPEC experts, including governors, national representatives and other technical officials, will this week discuss production allocations for every member country.

A major issue set to be raised by several countries is production estimates by secondary sources.

Saudi Arabia insists on using secondary sources when discussing production curbs and later monitoring compliance. This is likely to be opposed by some members, OPEC sources said.

For example, Iraq told OPEC its production in September was 4.775 million bpd, while secondary sources put the figure at 4.455 million bpd.

Venezuela is also dissatisfied with secondary-source estimations, the country's oil minister Eulogio Del Pino said this month.

"I think it is going to be very difficult for us and OPEC to reach a fair deal," said another OPEC source from a key Middle East oil producer.

(Reporting by Rania El Gamal; Editing by Dale Hudson)